Living with a Monetary System infected by Bubbles

Abstract

I study the real effects of bubbles in a price-settingenvironment. Bubbles cause price dispersion and overinvestment in assets that are overvalued. And when they pop some goods are not sold and capacity is not fully utilized. I argue that a government monopoly on the creation of bubble assets is desirable but may be difficult to achieve. A non-linear tax on capital gains and a “high” interest rate policy can play a role in protecting the government’s monopoly on the creation of bubble assets.