DP8038 Theoretical Notes on Bubbles and the Current Crisis
Author(s): | Alberto Martín, Jaume Ventura |
Publication Date: | October 2010 |
Keyword(s): | bubbles, credit constraints, dynamic inefficiency, financial accelerator, financial crisis, pyramid schemes |
JEL(s): | E32, E44, G01, O40 |
Programme Areas: | International Macroeconomics |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=8038 |
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.