Discussion paper

DP8038 Theoretical Notes on Bubbles and the Current Crisis

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 sectors and countries. We also use the model to explore the role of fiscal policy.

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Citation

Ventura, J and A Martín (2010), ‘DP8038 Theoretical Notes on Bubbles and the Current Crisis‘, CEPR Discussion Paper No. 8038. CEPR Press, Paris & London. https://cepr.org/publications/dp8038