This paper asks two main questions: (1) What makes some asset price bubbles more costly for the real economy than others? and (2)When do costly bubbles occur? We construct a model of rational bubbles under credit frictions and show that when bubbles held by banks burst this is followed by a costly financial crisis. In contrast, bubbles held by ordinary savers have relatively muted effects. Banks tend to invest in bubbles when financial liberalisation decreases their profitability.
Keywords: Rational bubbles; Financial Frictions; Financial Stability
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.