Working Paper: CEPR ID: DP8924
Authors: Vasco M. Carvalho; Alberto Martin; Jaume Ventura
Abstract: Over the last two decades U.S. aggregate wealth has fluctuated substantially. Against the backdrop of the Great Recession, the effects of these boom-and-bust cycles have come to dominate academic and policy discussions. How can we explain these fluctuations in wealth? Why are these fluctuations associated with changes in consumption, investment and output? In this note, we argue that answers to these questions entail the addition of two ingredients to existent macroeconomic models: rational bubbles and financial frictions. We explain why each of these building blocks is crucial to understand recent events and how they can be seamlessly integrated in standard models
Keywords: bubbles; bubbly episodes; dynamic inefficiency; economic growth; financial frictions
JEL Codes: E32; E44; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fluctuations in wealth (E32) | changes in consumption (D12) |
| fluctuations in wealth (E32) | changes in investment (E22) |
| fluctuations in wealth (E32) | changes in output (E23) |
| rational bubbles (E32) | asset prices exceed fundamental values (G19) |
| asset prices exceed fundamental values (G19) | investment decisions of entrepreneurs (G31) |
| rational bubbles (E32) | relax credit constraints (E51) |
| relax credit constraints (E51) | stimulate investment (E22) |
| stimulate investment (E22) | economic growth (O49) |
| negative investor sentiment (G41) | downturns (E32) |
| downturns (E32) | contraction of capital stock (E22) |
| contraction of capital stock (E22) | decrease in economic growth (O49) |