On rational exuberance

Stefano Bosi and Thomas Seegmuller

Mathematical Social Sciences, 2010, vol. 59, issue 2, 249-270

Abstract: In his seminal contribution, Tirole (1985) shows that an overlapping generations economy may monotonically converge to a steady state with a positive rational bubble, characterized by the dynamically efficient golden rule. The issue we address is whether this monotonic convergence to an efficient long run equilibrium may fail, while the economy experiences persistent endogenous fluctuations around the golden rule. Our explanation leads on the features of the credit market. We consider a simple overlapping generations model with three assets: money, capital and an asset paper, which behaves as a bubble. Collaterals matter because increasing the amount of capital and asset paper in the portfolio, the household reduces the share of consumption paid in cash. From a positive point of view, we show that the bubbly steady state can be locally indeterminate under arbitrarily small credit market imperfections and, thereby, persistent expectation-driven fluctuations of equilibria with (rational) bubbles can arise. From a normative point of view, monetary policies that are not too expansive are recommended in order to rule out the occurrence of sunspot fluctuations and enhance the welfare evaluated at the steady state.

Keywords: Bubbles; Collaterals; Indeterminacy; Cash-in-advance; constraint; Overlapping; generations (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (15)

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Related works:
Working Paper: On Rational Exuberance (2009)
Working Paper: On Rational Exuberance (2009)
Working Paper: On rational exuberance (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:matsoc:v:59:y:2010:i:2:p:249-270

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