TRANSACTION SERVICES AND ASSET-PRICE BUBBLES

Abstract

This paper examines asset-price bubbles in an economy where a nondepletable asset (e.g., land) can provide transaction services, using a variant of the cash-in-advance model. When a landowner can borrow money immediately using land as collateral, one can say that land essentially provides a transaction service. The transaction services that such an asset can provide increase as its price rises, as the asset owner can borrow more money against the asset's increased value. Thus, an asset-price bubble can emerge due to the externality of self-reference, wherein the asset price reflects the transaction services that it can provide, whereas the amount of the transaction services reflects the asset price. If the collateral ratio of the asset (θ) and money supply (m) are not very large, a steady-state equilibrium exists where the asset price has a bubble component and resource allocation is inefficient; if θ and/or m become large, the bubble component of the asset price vanishes and the equilibrium allocation becomes efficient. The paper shows that in the case where the equilibrium concept is relaxed to allow for sticky prices and a temporary supply-demand gap, an equilibrium exists where a bubble develops temporarily and eventually bursts.