Paper #848

Title:

Economic growth with bubbles

Authors:

Alberto Martin and Jaume Ventura

Date:

November 2003 (Revised: September 2011)

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.

Keywords:

bubbles, dynamic inefficiency, economic growth, financial frictions, pyramid schemes

JEL codes:

E32, E44, O40

Area of Research:

Macroeconomics and International Economics

Published in:

American Economic Review, 102 (6), 3033-3058, October 2012

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