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Benjamin Eden
''Should the Fed Increase the Interest Rate to Promote Financial Stability?''
I study the question in the title in an economy that may have overvalued assets that can pop and lead to financial instability. Assets with no fundamentals are not easily detected and can be distinguished from assets with fundamentals only if someone buys information about the underlying project. When information is not private, there is a strictly positive probability that no one will buy it and the bubble-like asset will have value. When the government increases the interest rate, assets with no fundamentals have no value but welfare goes down. Thus an increase in the interest rate may promote financial stability but reduce welfare.
Keywords: Financial Stability, Bubbles, Monetary Policy, Informational Externalities
JEL: E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General
D0 - Microeconomics: General
Manuscript Received : Jan 22 2016 Manuscript Accepted : Jan 26 2016

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