What is a bubble? Today’s economies often experience large
movements in asset prices that have significant macroeconomic
effects. Given that many of these movements in asset prices seem
unrelated to economic conditions or fundamentals, they have come
to be called bubbles, whether swelling or bursting. Typically,
these bubbles are unpredictable and generate substantial
macroeconomic effects. Consumption, the capital stock, and
output all tend to surge when a bubble arises and then collapse
or stagnate when the bubble bursts. Despite the recurrent nature
of bubbles and their macroeconomic implications, however, we
still lack a stylised model to answer the basic questions: -
What is the origin of bubbly episodes? - Why are they
unpredictable? - How do bubbles affect consumption, the capital
stock, and output? Of course, economists have long thought about
asset bubbles. To do so, they have found it useful to think of
an economy with two idealised asset classes: productive assets
or “capital” and pyramid schemes o