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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

Suggested Citation

  • Martin, Alberto & Ventura, Jaume, 2011. "Theoretical notes on bubbles and the current crisis," Working Paper Series 1348, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20111348
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    References listed on IDEAS

    as
    1. Ventura, Jaume, 2002. "Bubbles and Capital Flows," CEPR Discussion Papers 3657, C.E.P.R. Discussion Papers.
    2. Emmanuel Farhi & Ricardo Caballero & Pierre-Olivier Gourinchas, "undated". "Financial Crash, Commodity Prices and Global Imbalances," Working Paper 20933, Harvard University OpenScholar.
    3. Alberto Martin & Jaume Ventura, 2012. "Economic Growth with Bubbles," American Economic Review, American Economic Association, vol. 102(6), pages 3033-3058, October.
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    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.
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    More about this item

    Keywords

    bubbles; credit constraints; financial accelerator; financial crisis; pyramid schemes;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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