DP14367 Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies

Author(s): Robert Kollmann
Publication Date: January 2020
Date Revised: February 2020
Keyword(s): Boom-bust cycles, business cycles in closed and open economies, Dellas model, Long-Plosser model, non-linear DSGE models, Rational bubbles
JEL(s): C6, E1, E3, F3, F4
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14367

This paper studies rational bubbles in non-linear dynamic general equilibrium models of the macroeconomy. The term 'rational bubbles' refers to multiple equilibria arising from the absence of a transversality condition (TVC) for capital. The lack of TVC can be due to an overlapping generations structure. Rational bubbles reflect self-fulfilling fluctuations in agents' expectations about future investment. In contrast to explosive rational bubbles in linearized models (Blanchard (1979)), the rational bubbles in non-linear models here are stable and bounded. Bounded bubbles can generate persistent fluctuations of real activity, and capture key business cycle stylized facts. Both closed and open economies are analyzed. In a non-linear two-country model with integrated financial markets, bubbles must be perfectly correlated across countries.