Paper #1222

Title:

Theoretical notes on bubbles and the current crisis

Authors:

Alberto Martin and Jaume Ventura

Date:

May 2010 (Revised: February 2011)

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.

Keywords:

bubbles, dynamic inefficiency, financial accelerator, credit constraints, financial crisis, pyramid schemes.

JEL codes:

E32, E44, G01, O40.

Area of Research:

Macroeconomics and International Economics

Published in:

IMF Economic Review, 59 (1), 6-40, 2011

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