Asset Price Instability and Policy Responses: The Legacy of Liberalization

The problem of asset price bubbles, and more generally of instability in the financial system, has been a matter of concern since the 1980s but has only recently moved to the center of the macroeconomic policy debate. The main concern with bubbles arises when they burst, imposing losses on investors holding the bubble assets and potentially on the financial institutions that have extended credit to them. Asset price volatility is an inevitable consequence of financial market liberalization and, in extreme cases, generates asset price bubbles, the bursting of which can impose substantial economic and social costs. Policy responses within the existing liberalized financial system face daunting levels of uncertainty and risk. Given the pattern of increasing asset market volatility over recent decades and the policy issues highlighted in this paper, the future looks uncertain. Another significant cycle of asset price movements, especially in one of the major economies, could see a fundamental revision of thinking about the costs and benefits of liberalized financial systems.

Price stabilization and the risk-averse firm

An analytically simple and tractable approach to firm-level welfare analysis of complete and partial mean-preserving price stabilization for producers with general risk-averse preferences facing a stochastic technology is developed. Necessary and sufficient conditions for price stabilization to be welfare enhancing are derived under different assumptions of the producer's preferences and the producer's technology. Existing stabilization results for the risk-averse firm are shown to be corollaries of these more general results.

Output price subsidies in a stochastic world

This article studies the comparative statics of output subsidies for firms, with monotonic preferences over costs and returns, that face price and production uncertainty. The modeling of deficiency payments, support-price schemes, and stochastic supply shifts in a state-space framework is discussed. It is shown how these notions can be used, via a simple application of Shephard's lemma, to analyze input-demand shifts once comparative-static results for supply are available. A range of comparative-static results for supply are then developed and discussed.