Secular stagnation and rational bubbles: effects and nature of the interplay

In this work I focus on the effect of rational asset price bubbles in secular stagnation, an economic environment featuring sluggish economic activity, low inflation and zero or near-zero interest rates. In the first chapter, I clarify my research question by reviewing the emerging literature on secular stagnation. The secular stagnation theory provides sound theoretical and empirical grounds for interpreting the failure of the prevailing policy framework in the pre-crisis era. In secular stagnation, inflation targeting and contractionary fiscal policies are not effective, because a negative natural interest rate and price stability inhibit standard monetary policy tools and prevent full employment, which can be restored through structural reforms, in the long-run, and through expansionary fiscal policies or higher inflation, in the short-run. As these policy measures are not immediately and necessarily effective or they are unsustainable, low interest rates could foster asset price bubbles and this creates a policy trade-off: the policy makers could temporarily exploit the beneficial effect of financial instability at the cost of a more likely and harmful financial crisis in the future. In order to shed light on the nature of this trade-off, I investigate the effect of rational asset price bubbles in a low interest rates environment. In chapter 2, I explore the hypothesis that asset price bubbles postponed the low interest rates environment, which has followed the end of the Great Recession, by adding rational bubbles to the theoretical model of Eggertsson et al. (2017) and by assuming they provide an additional store of value. Rational bubbles play a crucial role, when a permanent demand shock hits the economy. They reallocate and decrease savings, counteracting the downward pressure put on interest rates by the structural shock. This allows the central bank to escape from the zero lower bound. In chapter 3, the model is further extended by assuming the existence of a bubbly collateral. In this way, I study an additional channel through which rational bubbles affect interest rates and measure the minimum size of the bubble which is necessary to avoid secular stagnation. By affecting saving and borrowing, asset price bubbles redistribute resources between generations and reduce the welfare of the representative agent. The redistribution of resources also reflects in higher interest rates. Even though the ``borrowing channel'' further raises interest rates by fostering debt accumulation and reducing savings, the ``saving channel'' mainly contributes to the increase in interest rates. This result has interesting implications for the design of policies aimed at managing asset price bubbles.