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Should Central Banks Burst Bubbles? Some Microeconomic Issues

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Executive Summary

Policy towards speculative bubbles is examined in a model of a finite horizon "Greater fool" bubble, with rational agents, asymmetric information and short-sales constraints. This model permits the use of standard tools of comparative dynamics and welfare economics to analyze bubble policies. Government policy is modeled as deflating overpriced assets by revealing information about this overpricing. The authors assume in this paper that the central bank only deflates assets if they are, in fact, overpriced. However, the central bank is never the only one to know that assets are overpriced.

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