I.The aim,significance and methods of the research

1.The aim and significance of the research

Whether or not the monetary policy should respond to bubbles and how the central bank should regulate the sharp fluctuations in asset prices have long been inconclusive either from theoretical models or from practical experience.In 2008,the US subprime mortgage crisis triggered by the pro-cyclicality of the financial system,that is,the positive feedback mechanism between the financial sector and the real economy,made asset bubbles and how to prevent systemic financial risks derived from them once again come back to the spotlight.After the international financial crisis，the central banks in developed economies,headed by the Federal Re-serve,had to launch unprecedented quantitative easing and even negative interest rate policies in order to inject the liquidity into the financial market and re-boost the economy.Undoubtedly,these unconventional policies have helped people step out of the haze of the crisis and helped the real economy recover,but at the same time,the side effects brought about by the surge in real estate price bubbles have also forced central banks to rush to raise interest rates in order to shrink balance sheets and gradually exit unconventional crisis response models.

Bubble is an old but constant concern.In history,the Tulip Mania in the 17th century and the South Sea Bubble in 1720 witnessed the rise and fall of asset bubbles（Kindleberger and Aliber,2011）.The Great De-pression between 1929 and 1933 caused far-reaching damage,after the stock market boom in the 1920s.In the late 1980s,Japan fell into the lost decade after the pre-bubble era（Okina and Shiratsuka,2002）.Similar events repeated in history.Debt crisis came soon after the Latin American credit boom of the early 1980s（Herrera and García,1998）.The Asian financial crisis broke out in 1997 and the subprime crisis in 2008 came one after another（Senhadji and Collyns,2002;Reinhart and Rogoff,2008），each more intense and influential than the other.Economic globalization has improved resource allocation efficiency through deep international spe-cialization,free trade and free capital flows.At the same time,the trans-parent financial markets and rapid movement of capital around the world，accompanied by complex information networks and frequent financial sys-tems,drive asset prices to rise and fall acutely.Financial markets are be-coming more and more unstable,financial crises may break out suddenly at any time,and the macroeconomic policy-making is facing more and more severe challenges.

Price stability is the cornerstone of financial stability.The reason why the prices of assets,including stocks,bonds,real estate,and foreign exchange,are unstable,stems from the reality that the trading market involves an intricate psychological game,as well as incomplete and asymmetric information between buyers and sellers in estimating price movements（Brunnermeier,2001）.With great uncertainty,rapidly changing market signals are easily misinterpreted by investors,leading to capital misallocation.Even more frightening,the misjudgments of investors only come to light when the trade ends after a time,when the economic conditions undergo a change.When asset prices rise to unacceptable levels,sudden plunges also snowball into collateral damages.As a result,even the regu lator is highly complete and sound,and the central bank owns extensive and transparent sources of information,people often see the problem only after the asset bubble has collapsed（Mishkin and White,2002）.Since small adjustments in monetary policy have a broad impact on financial markets and the economy as a whole,central banks cannot react separately to a particular type of asset price in face of a highly volatile asset price system.In addition,the root causes of various asset price fluctuations are very different,and a global regulation is very difficult to operate.What is more,policy interventions that recklessly burst the bubble will produce more far-reaching financial turmoil.

There is no denying that moderate inflation and asset bubbles under certain conditions are beneficial to the economy.It can play a benign role in stimulating consumption and investment,promoting capital accumulation and boosting economic growth.

Rising asset prices influence the spending decisions of residents and businesses with a favorable economic signal.For consumers,rising asset prices have a wealth effect,increasing individual asset values and property endowments.Optimistic expectations of increased wealth stimulate con-sumption through residents'inter-temporal smoothing behavior,and a stronger wealth endowment also provides reliable guarantees of micro-indi-viduals'excellent creditworthiness,reducing their loan costs.As a result，the financial situation of the households improves and the level of credit in-creases.For the productive sector,considering the credit transmission in financial markets,the moderate asset bubble expands the financing chan-nels of loan-constrained micro and small enterprises,improving the effi-ciency of capital allocation by realizing the transfer of funds from inefficient to high-producing enterprises,further boosting investment and output growth.However,as bubbles accumulate to a certain level,these positive stimulus effects can soon be reversed,producing extensive damage.While rising prices raise residents'wealth,overinflated market confidence tends to accumulate excessive debt,causing distortions and mismatches in resource endowments and consumption levels.By increasing the ratio of the market value of capital to its replacement cost,the inflation of asset bubbles increases Tobin＇s q（Tobin,1982）and boosts asset demand by continuously injecting liquidity into the market.

The amplification of the collateralized assets value in the credit market relax investors'external financing constraints,and the relatively lower costs of capital drive firms to expand production and capacity,increasing systemic risk in the financial markets.As a result of the excessive expansion of overall social investment and consumption,the real economy soon becomes overheated and the inflation kept climbing.In order to control inflation,monetary policy and credit policy have to tighten.In an imbalanced financial market,inflated asset prices eventually induce risks and concerns,and pessimistic expectations increasingly accumulate.When the majority of investors in the market panic seriously,the consequences of the race to sell assets are bound to be the falling of asset prices,and the bubble will eventually burst.Once the bubble burst,the ensuing liquidity risk brought a huge crisis to commercial banks:As the liabilities of commercial banks are mainly short-term deposits,while the assets of the long-term loans account for most,even big banks are difficult to survive.In addition,with the bubble burst and credit contraction,the insolvent middleclass and low-income people are more likely to take a beating since they are unable to repay their loans and even go bankrupt.In contrast,the property tycoons with information and capital advantages are more likely to seize the opportunity to exit the market first and make a fortune when prices fall.As a result,the income and wealth distribution gap widens further,undermining social stability and long-term economic growth.

Under a generally imperfect credit environment,essential capital mar kets such as stock and real estate markets present more dramatic volatility.Should governments intensify their policy interventions in managing the expansion of asset bubbles?Will tighter policy measures to raise interest rates be effective in suppressing bubbles and calming the pain of economic downturns?Tighter interest rates in an overheated economy have long been theoretically defended and promoted by mainstream macroeconomics,and policymakers have been firmly committed to strengthening regulation and intervention in financial markets for years in actual policy making.Nonetheless,empirical evidence around the world has consistently demonstrated that tight monetary policy has in many cases pushed up asset prices and inflated bubbles,raising many concerns.

In recent years,in order to manage the rising housing prices and reg-ulate real estate bubbles,China has taken a series of highly targeted and vigorous policy initiatives,including purchase limits and loan restrictions，active deleveraging movements,and tightening monetary policy regulation，yet the policy effectiveness is still not satisfactory.The nature of real estate bubbles that they are difficult to capture,difficult to measure,and difficult to control,brings monetary policy a lot of difficulties.And the intertwined condition of the real estate market and the real economy brings more diffi-cult for the governance of the property bubble.In addition,why is the tight monetary policy in the harsh credit environment unable to reverse the constant bad situation?Should central banks react directly to asset price fluctuations by considering them in the policy reaction function?Or should they keep their eyes on the ultimate goal of inflation and economic growth and take a wait-and-see attitude to bubbles?What role should financial regulators play in regulating housing price bubbles in the current environ-ment of imbalanced market supply and demand structures and structural problems in economic growth patterns?At its most basic level,how can the government effectively stop its infinite spread?Over the past decade,ex-cessive construction and investment projects in the real estate market have led to a rapid accumulation of unsustainable credit in China,leading to complex situations.Soaring housing prices have been accompanied by a large amount of unused housing stock.A large involuntary migration of the rural population to the cities has been accompanied by a rapid expansion of urban household debt,and at the macro level,government debt has risen to an unbelievable size accompanied by a large number of loopholes and risks lurking in the financial markets.

This book starts with the above questions,aiming to examine in depth the key challenges China＇s financial markets are facing,and to explore the underlying reasons why tight interest rate policies and strict capital controls,two policy measures that should work well together,have failed to solve these long-standing social problems.It also proposes targeted policy recommendations to guide the stable and healthy development of financial markets.This is of great significance to China's economy,which is under enormous pressure from an escalating trade war,and to other developing countries with similar problems.

2.Research methods

This study hypothesizes that“under an imperfect credit market environment（i.e.,the existence of credit frictions）,tight monetary policy not only fails to regulate the real estate market,but also stimulates the expansion of housing price bubbles”.The book focuses on a policy dilemma concerning people's livelihoods,which is the growing price bubbles in the real estate market under the deleveraging movement and interest rate raising in recent years,and proposes possible reasons for this abnormal occurrence,with well-founded speculations and explanations.Addressing the three main research objects of the“property price bubble”,“monetary policy transmission”and“credit mortgage constraints”,this book summarizes the causes of the formation of the housing price bubbles,the response of monetary policy,and the key role of the financial friction represented by mortgages in the transmission mechanism of the bubble.The empirical analysis verifies the hypothesis.

In the empirical analysis,in order to test the compatibility of the research hypothesis with the real economy,this book further analyzes the characteristic facts.Firstly,it measures the house price bubbles in China based on the State Space Model,and then conducts an empirical study of the impact of monetary policy on the real estate bubbles in China using China＇s macroeconomic time series with constant coefficients and Time-varying coefficients Vector Auto-regressive models,respectively.Using statistical tools and econometric methods,this book incorporates the characteristic facts of the Chinese economy into the research framework,tests the research hypotheses with actual data,and also provides a logical mechanism for the later derivation of the general equilibrium theory of the transmission mechanism of monetary policy on the house price bubble under the collateral constraint,providing a more solid basis for the conclusions and policy recommendations.

In the theoretical model,after characterizing the facts and empirical evidence to test the research hypotheses,this book systematically composes the theoretical foundations and frameworks of the Dynamic Stochastic Gen-eral Equilibrium Model（DSGE）and Financial Frictions in the Credit Market（FFCM）,and establishes an Over-lapping Generation Model in which the financing process is constrained by loan collateral,and bubbles in the real estate market are introduced into the transactions of representa-tive households in the model.By establishing an intertemporal optimal de-cision function for consumers,the book derives a proof of the unique exist-ence of a steady-state bubble equilibrium,a mathematical proof of the conclusion,and a mechanism decomposition of the“collateral mechanism”and the“interest rate mechanism”in a comparative static analysis.By calibrating parameters that are consistent with Chinese reality and economic theory,the book further simulates and estimates the complete general equilibrium theoretical model numerically,and obtains dynamic results from impulse response analysis.Furthermore,the book systematically explains the complete transmission mechanism of monetary policy to real estate price bubbles theoretically,and discusses the role and impact of financial frictions in the credit market in this transmission mechanism.

II.Main content and key points

The central point of this book is as follows.Given the collateral mechanism in the credit constraint,the expansionary effect of tight monetary policy（rising interest rates）on rational real estate price bubbles is further enhanced and amplified if investors'access to credit is more tightly restricted.The logical explanation for this inference is as follows:For speculative real estate bubbles that are not productive,they enter the capital market as part of the collateral assets available for holders to guarantee to financial intermediaries and raise loans.According to standard asset pricing theory,these bubble assets,which have no intrinsic value and do not generate real returns,are driven by investor sentiment,and therefore expand as market returns increase（called the “interest rate mechanism”）.In addition to collateral housing assets,individuals also hold dividend-paying assets of productive enterprises and use them as collateral for loans,which are referred to in this book as“physical collateral assets”.Thus,bubble collateral assets and physical collateral assets together form a collateral asset pool that can be used by the representative investors in this model to obtain loans from banks to meet liquidity needs.Under intense deleveraging movements,credit conditions tighten and investors are subject to financial constraints and liquidity pressures.At this point,if the monetary authority announces a tight monetary policy,the corresponding increase in production costs with rising interest rates reduces the speed of capital accumulation and slows production,causing the total social value of ordinary collateralizable assets to contract.Therefore,when investors are constrained by tight credit constraints and cannot borrow e-nough money with existing physical collateral assets,they will spontane-ously hold more bubble collateral assets to relieve the liquidity shortage，and the real estate bubble will further appreciate due to its collateralized properties.

III.Academic Innovation and Contribution

The main contribution and innovation of this book are summarized as follows.This book investigates the transmission mechanism of monetary policy on real estate price bubbles from the perspective of loan collateral constraints,and provides a comprehensive analysis of the policy effects arising from the combination of interest rate raising and deleveraging movements to give possible explanations for the puzzling real estate bubbles that current policies have been unable to resolve.

First,this book develops an over-lapping generation（OLG）model into a general equilibrium framework.China＇s financial market has undergone a deterioration of the lending environment and inflated asset bubbles arising from tightened monetary policies.This model is an attempt to explain the policy dilemma of why various real estate regulation policies have failed to control the bubble.

In the previous studies that focused on the policy of how to control the housing bubble,few scholars have conducted a comprehensive and systematic perspective on the compound effect of the double austerity measures characterized by“interest rate raising”+“deleveraging”.This book focuses on the mortgage ability of housing bubble assets in investors'loan portfolios,seriously analyzes the role of the collateral mechanism in the transmission mechanism of monetary policy on asset bubbles,and explores the impact of the interest rate on the economy.Although there are numer-ous studies on the monetary policy transmission mechanism of asset prices，the crux of mortgage finance as a bubble asset is not well studied.This book adopts the New Keynesian framework,which has been widely used in literature of monetary policy and capital markets,in order to better fit the stylized facts of how real estate markets work and to provide a more com-prehensive analysis of the effect on the purchase decisions of overlapping generation households.

Second,this book attempts to make several meaningful extensions to the previous seminal theoretical research.The potential extension is sum-marized as follows:（i）In the context of capital market transactions,the book extends the assumption in Farhi and Tirole（2011）that only entre-preneurs can hold bubble assets by allowing workers to hold asset bubbles，leading to a wider range of bubble transactions.Considering the current re-alistic background of a steady rise in national house prices and universal home buying,the common participation of all investors in the trading of re-al estate bubble assets resonates better with the economic reality of China.（ii）In response to the crowd-out effect of bubble expansion on capital ac-cumulation proposed by Martin and Ventura（2012,2016）,this book fur-ther decomposes the collateral mechanism from the original interest rate mechanism to provide solid theoretical support.Specifically,this book demonstrates the amplifying effect of financial frictions in the form of credit constraints on bubble expansion,and deeply analyzes how the growth of the real estate bubble（house prices keep soaring）and the slowdown of capital accumulation in the production process（the decrease in the growth of real enterprises and the shutdown of highly productive enterprises）in-teract with each other.（iii）Previous studies,including Wang and Wen（2012）,Miao and Wang（2012,2018）,use the infinite-horizon model as a theoretical framework,and focus on the impact of stock market bubbles that generate real dividends on investment and capital reallocation.Relating to their ideas,this book focuses the main body of research on pure bubble-type assets used as a means of storing value by economic individuals with overlapping generations.

Third,most scholars studying real estate bubbles and monetary policy have focused their analyses on the U.S.market（Poterbaetal.1991;Iaco-viello 2005;Brunnermeier and Julliard 2008;Genesove and Han 2012），and have not delved deeply into the Chinese economy,which currently has enormous academic potential.This book provides a detailed empirical a-nalysis of the impact of China＇s monetary policy on the real estate market bubble by using Chinese macroeconomic time series data.Given that the large-scale securitization of property market assets and the long-accumula-ted liquidity pressure on lenders have attracted much attention from politi-cal and academic scholars and widespread public debate,this book pro-vides a logical and data-supported interpretation for the possibility that mi-cro-individuals with financial constraints have been subjected to the nega-tive impact of lifting interest rates against the background of the difficulties in raising debt.As a consequence of the negative monetary policy shock of“interest rate raising”,they were forced to turn to the real estate market for additional liquidity to solve their debt problems,as their own produc-tion slowdown could not alleviate their liquidity requirements.This conclu-sion has important implications for the long-term sustainability of China's financial markets.

Key words:Housing Bubbles,Monetary Policy,Credit Constraint，Financial Friction,Dynamic Stochastic General Equilibrium Theory