Speculative Growth: Hints from the U.S. Economy

By Ricardo J. Caballero, Emmanuel Farhi, M. Hammour. 2006

134 citations recorded by the source corpus.

We propose a framework for understanding recurrent historical episodes of vigorous economic expansion accompanied by extreme asset valuations, as exhibited by the U.S. in the 1990s. We interpret this phenomenon as a high-valuation equilibrium with a low effective cost of capital based on optimism about the future availability of funds for investment. The key to the sustainability of such an equilibrium is feedback from increased growth to an increase in the supply of effective funding. We show that such feedback arises naturally when an expansion comes with technological progress in the capital producing sector, when fiscal rules generate sustained fiscal surpluses, when the rest of the world has lower expansion potential, and when financial constraints are relaxed by the expansion itself. Arguably, these ingredients were all simultaneously present in the U.S. during the 1990s. We also show that such expansions can be welfare improving but they can crash. The latter is more likely if bubbles develop along the expansionary path. These (rational) bubbles can emerge even when the interest rate exceeds the rate of growth of the economy.

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/8e67ec28ef36c8398c07e26c99bb48533e697c16

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Citations in the corpus

Bubbles and Capital Flow Volatility: Causes and Risk Management (2006, unknown): “More closely related to our paper in terms of the focus on fragility, is that of Caballero et al. (2004) where bubbles may increase the chance of a crash in a multiple equilibria economy.”
Do Stock Prices Influence Corporate Decisions? Evidence from the Technology Bubble (2013, unknown): “More broadly, our ndings are consistent with recent macroeconomic theories suggesting that stock market booms shift investment spending towards nancially constrained rms, stimulating corporate sector growth (see Jermann and Quadrini (2006) and Caballero et al. (2006)).”
On the Macroeconomics of Asset Shortages (2006, methodology): “In fact, in Caballero et al (2006a) , we show that under certain conditions, bubbles must exist.4 That is, in the absence of a speculative bubble, there is an”
Sectoral bubbles, misallocation, and endogenous growth☆ (2014, background): “Caballero et al. (2006) introduce capital adjustment costs to the Diamond–Tirolemodel and study the episodes of speculative growth.”
Asset Prices, Exchange Rates and the Current Account (2007, background): “In particular, Caballero et al. (2006) and Ju and Wei (2006) argue that the lack of nancial assets and incompleteness of asset markets in emerging market economies (EMEs) is key for understanding the direction of capital ows from poor to rich countries and its composition, the ample liquidity in…”
House Prices, Collateral and Self-Employment (2013, unknown): “This is consistent with a “bright side” of bubbles (as suggested in Caballero, Farhi, and Hammour, 2006, although the effect we emphasize is quite different).”
The State of Macro (2009, background): “Recent research has explored whether, in the presence of other credit market imperfections, rational bubbles may exist even when the economy is dynamically efficient (Ventura 2003, Caballero et al. 2006).”
An Equilibrium Model of Global Imbalances and Low Interest Rates (2008, unknown): “For example, in an earlier version of this paper (Caballero et al. (2006b)), we showed how the growth gap that developed between the US and Continental Europe during the 1990s generates patterns in our model which are consistent with the data.”