Rational bubbles and expectation‐driven fluctuations

Abstract

In this paper, we propose a unified approach to understand the fluctuations of a rational bubble. We focus on an overlapping generations exchange economy where each household makes a portfolio choice between money, held because of a liquidity constraint, and another asset with no fundamental value. We show the existence of equilibria where the second asset takes a positive value as a pure rational bubble. There may exist endogenous cycles and bubble fluctuations driven by the volatility of agents' expectations. An expansionary monetary policy can shelter the economy from these endogenous fluctuations, but this positive effect is counterbalanced by a welfare loss according to the Friedman critique: there is a trade-off between the stability and the stationary welfare target. Eventually, we consider a temporary bubble on real balances as an alternative source of self-fulfilling cycles.

Introduction to international financial markets and banking systems crises

“…In order to stabilize the economy, the authors show that a monetary policy rule responding only to expected inflation has a destabilizing effect, while a monetary rule responding also to asset prices can be stabilizing and rules out the multiplicity of steady states. 6 However, this type of contributions does not provide any information of international transmissions of bubbles. A few recent papers focus on such a question but assuming initially that the different bubbles comove (see e.g.…”

“…See also Bosi and Seegmuller[5,6] for related results, and Bidian[3] for a general analysis of bubbles under various sources of frictions.…”