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Theoretical notes on bubbles and the current crisis

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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.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1222.

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Date of creation: May 2010
Date of revision: Feb 2011
Handle: RePEc:upf:upfgen:1222

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Web page: http://www.econ.upf.edu/

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Keywords: bubbles; dynamic inefficiency; financial accelerator; credit constraints; financial crisis; pyramid schemes.;

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  1. Caballero, Ricardo & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2008. "Financial Crash, Commodity Prices and Global Imbalances," CEPR Discussion Papers 7064, C.E.P.R. Discussion Papers.
  2. Ventura, Jaume, 2002. "Bubbles and Capital Flows," CEPR Discussion Papers 3657, C.E.P.R. Discussion Papers.
  3. Alberto Martin & Jaume Ventura, 2012. "Economic Growth with Bubbles," American Economic Review, American Economic Association, vol. 102(6), pages 3033-58, October.
  4. 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.
  5. Aart Kraay & Jaume Ventura, 2005. "The Dot-Com Bubble the Bush Deficits, and the U.S. Current Account," NBER Working Papers 11543, National Bureau of Economic Research, Inc.
  6. Charles T. Carlstrom & Timothy S. Fuerst, 1996. "Agency costs, net worth, and business fluctuations: a computable general equilibrium analysis," Working Paper 9602, Federal Reserve Bank of Cleveland.
  7. Grossman, G.M. & Yanagawa, N., 1992. "Asset Bubbles and Endogenous Growth," Papers 160, Princeton, Woodrow Wilson School - Public and International Affairs.
  8. Ricardo J. Caballero & Arvind Krishnamurthy, 2005. "Bubbles and Capital Flow Volatility: Causes and Risk Management," NBER Working Papers 11618, National Bureau of Economic Research, Inc.
  9. King, Ian & Ferguson, Don, 1993. "Dynamic inefficiency, endogenous growth, and Ponzi games," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 79-104, August.
  10. Saint-Paul, G., 1991. "Fiscal Policy In An Endogenous Growth Model," DELTA Working Papers 91-04, DELTA (Ecole normale supérieure).
  11. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  12. Jesús Fernández-Villaverde & Lee Ohanian, 2010. "The Spanish Crisis from a Global Perspective," Working Papers 2010-03, FEDEA.
  13. 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.
  14. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, vol. 53(6), pages 1499-1528, November.
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