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'Irrational exuberance' and capital flows for the US New Economy: a simple global model

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  • Marcus Miller
  • Olli Castrén

    (European Central Bank, Germany)

  • Lei Zhang

Abstract

In a stylized and analytically tractable model of the global economy, we first calculate the Pareto improvement when a country experiencing a favourable supply side shock consumes more against expected future output and spreads the risk by selling shares. With capital inflows to finance the 'New Economy' significantly exceeding the current account deficit, we then show that selling shares globally at inflated prices-due to 'irrational exuberance' and|or distorted corporate incentives-can generate significant international transfers when the asset bubble bursts. Our analysis complements econometric studies showing how much the European economy was affected when the US asset boom ended. Copyright © 2007 John Wiley & Sons, Ltd.

Suggested Citation

  • Marcus Miller & Olli Castrén & Lei Zhang, 2007. "'Irrational exuberance' and capital flows for the US New Economy: a simple global model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 12(1), pages 89-105.
  • Handle: RePEc:ijf:ijfiec:v:12:y:2007:i:1:p:89-105
    DOI: 10.1002/ijfe.307
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    References listed on IDEAS

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    1. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2008. "International Risk Sharing and the Transmission of Productivity Shocks," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 443-473.
    2. Marcus Miller & Paul Weller & Lei Zhang, 2002. "Moral Hazard and the US Stock Market: Analysing the "Greenspan Put"," Economic Journal, Royal Economic Society, vol. 112(478), pages 171-186, March.
    3. Ana Beatriz Galvão & Michael Artis & Massimiliano Marcellino, 2007. "The transmission mechanism in a changing world," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 39-61.
    4. Bayoumi, Tamim & Laxton, Douglas & Pesenti, Paolo, 2004. "Benefits and spillovers of greater competition in Europe: a macroeconomic assessment," Working Paper Series 341, European Central Bank.
    5. Miller, Marcus & Stiegert, Roger & Castrén, Olli, 2003. "Growth expectations, capital flows and international risk sharing," Working Paper Series 237, European Central Bank.
    6. Raghuram G. Rajan, 2005. "Has financial development made the world riskier?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Aug, pages 313-369.
    7. Eloïc Peyrache & Lucía Quesada, 2011. "Intermediaries, Credibility and Incentives to Collude," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 20(4), pages 1099-1133, December.
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    Cited by:

    1. Marcus Miller & Lei Zhang, 2006. "Capital Flows, Interest Rates and Precautionary Behaviour: a model of "global imbalances"," WEF Working Papers 0014, ESRC World Economy and Finance Research Programme, Birkbeck, University of London.

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