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Theoretical notes on bubbles and the current crisis

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  • Martin, Alberto
  • Ventura, Jaume

Abstract

We explore a view of the crisis as a shock to investor sentiment that led to the collapse of a bubble or pyramid scheme in financial markets. We embed this view in a standard model of the financial accelerator and explore its empirical and policy implications. In particular, we show how the model can account for: (i) a gradual and protracted expansionary phase followed by a sudden and sharp recession; (ii) the connection (or lack of connection!) between financial and real economic activity and; (iii) a fast and strong transmission of shocks across countries. We also use the model to explore the role of fiscal policy. JEL Classification: E32, E44, G01, O40

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1348.

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Date of creation: Jun 2011
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Handle: RePEc:ecb:ecbwps:20111348

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Keywords: bubbles; credit constraints; financial accelerator; financial crisis; pyramid schemes;

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  1. Saint-Paul, G., 1991. "Fiscal Policy In An Endogenous Growth Model," DELTA Working Papers 91-04, DELTA (Ecole normale supérieure).
  2. Jesús Fernández-Villaverde & Lee Ohanian, 2010. "The Spanish Crisis from a Global Perspective," Working Papers 2010-03, FEDEA.
  3. Azariadis Costas & Smith Bruce D., 1993. "Adverse Selection in the Overlapping Generations Model: The Case of Pure Exchange," Journal of Economic Theory, Elsevier, vol. 60(2), pages 277-305, August.
  4. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2008. "Financial Crash, Commodity Prices and Global Imbalances," NBER Working Papers 14521, National Bureau of Economic Research, Inc.
  5. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66, pages 467.
  6. King, Ian & Ferguson, Don, 1993. "Dynamic inefficiency, endogenous growth, and Ponzi games," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 79-104, August.
  7. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  8. Martin, Alberto & Ventura, Jaume, 2010. "Economic Growth with Bubbles," CEPR Discussion Papers 7770, C.E.P.R. Discussion Papers.
  9. Aart Kraay & Jaume Ventura, 2007. "The Dot-Com Bubble, the Bush Deficits, and the U.S. Current Account," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 457-496 National Bureau of Economic Research, Inc.
  10. Grossman, G.M. & Yanagawa, N., 1992. "Asset Bubbles and Endogenous Growth," Papers 160, Princeton, Woodrow Wilson School - Public and International Affairs.
  11. Jaume Ventura, 2002. "Bubbles and capital flows," Economics Working Papers 846, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2010.
  12. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2006. "Bubbles and capital flow volatility: Causes and risk management," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 35-53, January.
  13. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers 1995-5, Edinburgh School of Economics, University of Edinburgh.
  14. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
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