Bubbly Recessions

Abstract

We develop a tractable bubbles model with financial friction and downward wage rigidity. Competitive speculation in risky bubbles can result in excessive investment booms that precede inefficient busts, where post-bubble aggregate economic activities collapse below the pre-bubble trend. Risky bubbles can reduce ex ante social welfare, and leaning-against-the-bubble policies that balance the boom-bust trade-off can be warranted. We further show that the collapse of a bubble can push the economy into a “secular stagnation” equilibrium, where the zero lower bound and the nominal wage rigidity constraint bind, leading to a persistent recession, such as the Japanese “lost decades.” (JEL E22, E24, E32, E44, L26)

Recurrent Bubbles and Economic Growth

“…This is interesting research because there is a concern that the theoretical literature on bubbles traditionally emphasizes their upside disproportionately and, as a result, does not address the types of issues policymakers care most about (Barlevy (2018)). Speci…cally, Allen, Barlevy, and Gale (2017) and Biswas, Hanson, and Phan (2018) show that stagnation in output occurs after the bursting of bubbles in models without growth. Because the stagnation in output is costly, it makes the welfare impact of bubbles non-trivial even if bubbles raise the output level when they are present.…”

Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms

“…Generally, monetary models of asset price bubbles suggest that tighter monetary policy and higher borrowing costs reduce the size of bubbles and their macroeconomic consequences. In Dong, Miao, and Wang (2020) and Biswas, Hanson, and Phan (2020), for instance, tighter monetary policy can reduce the volatility of the bubble and prevent prolonged economic recessions once the bubble bursts. Gali (2014Gali ( , 2021 reaches the opposite conclusion in a model in which the short-term policy rate helps pin down the growth rate of asset price bubbles, finding that systematic tightening in response to a rational asset price bubble can increase its volatility.…”

Credit Booms, Debt Overhang and Secular Stagnation

“…In addition, some recent contributions analyze the effects of (the burst of) asset price bubbles on economic growth (cf. Boullot, 2017;Hanson and Phan, 2017;Biswas et al, 2017).…”

“…Finally, Schmitt-Grohé and Uribe (2016,2017) introduce an exogenous lower bound on the growth rate of the nominal wage that becomes binding in case of unemployment. The same mechanism is used by Hanson and Phan (2017) and Biswas et al (2017).…”