Economic Growth with Bubbles

• Authors: Jaume Ventura and Alberto Martin.
• BSE Working Paper: 110916 | September 15
• Keywords: Bubbles , economic growth , dynamic inefficiency , financial frictions , pyramid schemes
• JEL codes: E32, E44, O40
• Bubbles
• economic growth
• dynamic inefficiency
• financial frictions
• pyramid schemes

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, unproductive investors demand bubbles while productive investors supply them. Because of this, bubbly episodes channel resources towards productive 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.