Working Paper: CEPR ID: DP8038
Authors: Alberto Martin; Jaume Ventura
Abstract: We explore a view of the crisis as a shock to investor sentiment that led to the collapse of a bubble or pyramid scheme in financial markets. We embed this view in a standard model of the financial accelerator and explore its empirical and policy implications. In particular, we show how the model can account for: (i) a gradual and protracted expansionary phase followed by a sudden and sharp recession; (ii) the connection (or lack of connection!) between financial and real economic activity and; (iii) a fast and strong transmission of shocks across sectors and countries. We also use the model to explore the role of fiscal policy.
Keywords: bubbles; credit constraints; dynamic inefficiency; financial accelerator; financial crisis; pyramid schemes
JEL Codes: E32; E44; G01; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| investor sentiment (G41) | market valuations (G19) |
| optimistic sentiment (E66) | overvaluation (bubbles) (F31) |
| pessimism (D84) | credit contractions (E51) |
| market valuations (G19) | net worth of entrepreneurs (L26) |
| net worth of entrepreneurs (L26) | credit expansion (E51) |
| bubbles burst (E32) | decline in net worth (D14) |
| decline in net worth (D14) | contraction in credit availability (E51) |
| collapse of bubbles (E32) | economic downturn (F44) |
| investor sentiment (G41) | credit expansion (E51) |
| investor sentiment (G41) | economic booms (E32) |
| credit expansion (E51) | economic booms (E32) |