DP7770 Economic Growth with Bubbles

Author(s): Alberto Martín, Jaume Ventura
Publication Date: April 2010
Keyword(s): asset bubbles, dynamic inefficiency, economic growth, financial frictions, pyramid schemes
JEL(s): E32, E44, O40
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7770

We develop a stylized model of economic growth with bubbles. In this model, financial frictions lead to equilibrium dispersion in the rates of return to investment. During bubbly episodes, relatively inefficient investors demand bubbles while relatively efficient investors supply them. Because of this, bubbly episodes channel resources towards efficient investment raising the growth rates of capital and output. The model also illustrates that the existence of bubbly episodes requires some investment to be dynamically inefficient: otherwise, there would be no demand for bubbles. This dynamic inefficiency, however, might be generated by an expansionary episode itself.