«Should Monetary Authorities Prick Asset Price
Bubbles? Evidence from a New Keynesian Model with an Agent-Based Financial Market»

Abstract
We developed the approach in the macroeconomic literature, which is based on the synthesis of New Keynesian macroeconomics and agent-based models, and build a model, allowing for the incorporation of stochastic and realistic dynamics of financial markets, which is set by an agent-based model of a financial market, in the one of the traditional New Keynesian frameworks - the financial accelerator model of BGG(1999),. Using our model, we obtain a new evidence for the answer ton the question of how central banks should prick asset price bubbles for the maximization of social welfare and for the preserving of financial stability, which, surprisingly, has almost has not been studied in the literature yet. Our results show that pricking asset price bubbles can be a policy, which enhances social welfare, and reduces the volatility of output and inflation, especially, in the cases, when asset price bubbles are caused by credit expansion, or when the central bank provides effective information policy. We also argue that pricking asset price bubbles with the lack of the effectiveness of information policy, only by raising the interest rate, leads to negative consequences to social welfare and financial stability.

Conclusion
In the paper, we develop the approach in the macroeconomic literature, which is based on the synthesis of New Keynesian macroeconomics and agent-based models. For this purpose, we construct a joint model that consists of the traditional New Keynesian framework – the financial accelerator model of BGG(1999), which sets the real sector, and the agent-based model of the financial market, on which traders determine the market price of assets by selling and buying assets from each other. The real sector and the financial market are connected through 4four transmission mechanisms: the dynamics of the financial market determines the market price of assets in the real sector, the real sector affects traders’ expectations on the financial market about the fundamental price of assets, the central bank can also affect traders’ expectations, and there are liquidity flows between the real sector and the financial market. The model allows for the existence of bubbles on the financial market, and considers the case, when the central bank can raise the interest rate beyond the Taylor rule, in order to prick asset price bubbles.
Using the model, we receive a new evidence in the literature that in some cases, pricking asset price bubbles by the central bank can reduce the social welfare losses from asset bubbles, as well as the volatility of output and the volatility of inflation. This effect is larger, especially in the cases, when asset price bubbles are caused by credit expansion, or when the central bank provides effective information policy, or, in other words, it can effectively influence traders’ expectations. Our results also show that pricking asset price bubbles only by raising the interest rate with the lack of the effectiveness of information policy leads to negative consequences for social welfare and financial stability.
The promising direction of the future research can be the quantitative estimation of the parameters of an agent-based financial market on the real data in the cases of financial bubbles, in order to find the optimal time of pricking bubbles by the central bank in the historical cases. We hope that this direction will also allow for the analysis of the optimal time of pricking bubbles in the future cases in the real time. Our model is also can be used for the quantitative estimation of the effect of the central bank’s information policy. Furthermore, the approach from our model can be implemented for the analysis of how behavioral factors in financial markets can influence the rest of the economy.