Efficient Bubbles?

Valentin Haddad, Erik Loualiche and Paul Ho
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Valentin Haddad: University of California, Los Angeles
Erik Loualiche: University of Minnesota

No 1087, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: Episodes of booming firm creation often coincide with intense speculation on financial markets. We show that while speculation leads to more firm entry, it might actually mitigate over-entry, leading to efficient innovative booms. More broadly, disagreement among investors completely transforms the economics of optimal firm creation. We characterize the interaction between speculation and classic entry externalities from growth theory through a general entry wedge formula for a non-paternalistic planner. The business-stealing effect is mitigated when investors believe they can identify the best firms; hence more entry goes along with less excess entry. The appropriability effect also vanishes, leaving only general equilibrium effects on input prices, aggregate demand, or knowledge. As a result, speculation reverses the role of many industry characteristics such as the labor share for efficiency. Further, economies with identical aggregate properties but a different market structure have the same efficiency with agreement, but differ in presence of bubbles.

Date: 2018
New Economics Papers: this item is included in nep-bec and nep-dge
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