Monetary policy and asset price bubbles: a laboratory experiment

Abstract

Leaning-against the-wind (LAW) policies, whereby interest rates are raised in the face of a growing asset price bubble, are often advocated as a means of dampening such bubbles. On the other hand, there are theoretical arguments suggesting that such a policy could have the opposite effect (Gal í, 2014). We study the effect of monetary policy on asset price bubbles in a laboratory experiment with an overlapping generations structure. Participants in the role of the young generation allocate their endowment between two investments: a risky asset and a one-period riskless bond. The risky asset pays no dividend and thus the possibility of selling it to the next generation is its only source of value. [...]