Asset Price Booms and Macroeconomic Policy: A Risk-Shifting Approach†

This paper uses a risk-shifting model to analyze policy responses to asset price booms. We show risk shifting leads to inefficient asset and credit booms in which asset prices can exceed fundamentals. However, the inefficiencies associated with risk shifting arise independently of whether the asset is a bubble. Given evidence of risk shifting, policymakers may not need to determine if assets are bubbles to justify intervention. We then show that some of the main candidate interventions against asset booms have ambiguous welfare implications: tighter monetary policy can mitigate some inefficiencies but at a cost, while leverage restrictions may raise asset prices and lead to more leveraged speculation rather than less. Policy responses are more effective when they disproportionately discourage riskier investments.