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Economic growth with bubbles

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Abstract

We develop a stylized model of economic growth with bubbles. In this model, changes in investor sentiment lead to the appearance and collapse of macroeconomic bubbles or pyramid schemes. We show how these bubbles mitigate the effects of financial frictions. During bubbly episodes, unproductive investors demand bubbles while productive investors supply them. These transfers of resources improve the efficiency at which the economy operates, expanding consumption, the capital stock and output. When bubbly episodes end, these transfers stop and consumption, the capital stock and output contract. We characterize the stochastic equilibria of the model and argue that they provide a natural way of introducing bubble shocks into business cycle models.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 848.

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Date of creation: Nov 2003
Date of revision: Sep 2011
Handle: RePEc:upf:upfgen:848

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

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Keywords: bubbles; dynamic inefficiency; economic growth; financial frictions; pyramid schemes;

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