Asset bubbles, economic growth, and a self-fulfilling financial crisis: a dynamic general equilibrium model of infinitely lived heterogeneous agents

MPRA Paper from University Library of Munich, Germany

Abstract: We develop a dynamic general equilibrium growth model with infinitely lived heterogeneous agents to describe a self-fulfilling financial crisis accompanied by an asset bubble burst as a rational expectations equilibrium. Because of financial market imperfections, asset bubbles appear under mild parameter conditions even though we assume infinitely lived agents. Although these bubbles have both a crowd-in liquidity effect and a crowd-out effect on investment, the former effect always dominates the latter. Thus, a self-fulfilling financial crisis accompanied by an asset bubble burst results in an economic recession. This phenomenon is consistent with empirical observations on financial crises in the existing literature. In addition, we present an effective government policy to avoid self-fulfilling financial crises.

Keywords: Crowd-in effect of bubbles; Financial market imperfections; Sunspots; Self-fulfilling financial crisis; Economic growth (search for similar items in EconPapers)
JEL-codes: E44 (search for similar items in EconPapers)
Date: 2012-03-13
New Economics Papers: this item is included in nep-dge, nep-fdg and nep-mac
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:37309

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