Switching bubbles: From Outside to Inside Bubbles |
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| Institution: | 1. Faculty of Mechanical Engineering, Technion – Israel Institute of Technology, Technion City, 32000 Haifa, Israel;2. Department of Continuum Mechanics and Structural Analisis, University of Carlos III of Madrid, Avda. de la Universidad 30, 28911 Leganés, Madrid, Spain;1. Department of Economics and Knut Wicksell Centre for Financial Studies, Lund University, P.O. Box 7082, S-220 07 Lund, Sweden;2. Kedge Business School, France;1. Turku School of Economics, University of Turku, Finland;2. Financial Stability and Statistics Department, Bank of Finland, Finland;3. Monetary Policy and Research Department, Bank of Finland, Finland;1. Department of Economics, University College London, 30 Gordon Street, London WC1H 0AX, United Kingdom;2. Federal Reserve Bank of Chicago, Chicago, IL 60604, USA;3. Institute for Fiscal Studies, London WC1E 7AE, United Kingdom;4. Board of Governors of the Federal Reserve System, Washington, DC 20551, USA;5. National Bureau of Economic Research, Cambridge, MA 02138, USA |
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| Abstract: | The United States has recently experienced two asset price bubbles: the Dot-Com and the Housing Bubbles. These bubbles had very different effects on investment and debt of manufacturing firms. In this paper I develop a framework to understand the differential effect of two types of rational bubbles. I distinguish between (i) Outside Bubbles, which I define as savers purchasing and selling costless assets not-attached to inputs of production and (ii) Inside Bubbles, which I define as savers buying an input of production (e.g., land or houses) only as a store of value. The model is an OLG economy with savers and entrepreneurs. Savers save to consume when they are old. Entrepreneurs can borrow to invest but they face a collateral constraint. In this environment, rational bubbles can emerge. I show that the size of an Inside Bubble is larger. I also find that when the economy switches from an Outside to an Inside Bubble, manufacturing (or non-housing) investment and debt is lower, consistent with the U.S. experience. Finally, I show that even though steady-state consumption is higher with an Outside Bubble, a social planner would prefer an Inside Bubble when the productivity of entrepreneurs is low. |
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| Keywords: | Rational bubbles Collateral constraint Investment Debt |
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