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Recurrent Bubbles, Economic Fluctuations, and Growth

March 12, 2018
Pablo A. Guerron-Quintana*1
Tomohiro Hirano*2
Ryo Jinnai*3


We propose a model that generates permanent effects on economic growth following a recession (super hysteresis). Recurrent bubbles are introduced to an otherwise standard infinite-horizon business-cycle model with liquidity scarcity and endogenous productivity. In our setup, bubbles promote growth because they provide liquidity to constrained investors. Bubbles are sustained only when the financial system is under-developed. If the financial development is in an intermediate stage, recurrent bubbles can be harmful in the sense that they decrease the unconditional mean and increase the unconditional volatility of the growth rate relative to the fundamental equilibrium in the same economy. Through the lens of an estimated version of our model fitted to U.S. data, we argue that 1) there is evidence of recurrent bubbles; 2) the Great Moderation results from the collapse of the monetary bubble in the late 1970s; and 3) the burst of the housing bubble is partially responsible for the post-Great Recession dismal recovery of the U.S. economy.

This work was presented at the Seventh Joint Conference Organized by the University of Tokyo Center for Advanced Research in Finance and the Bank of Japan Research and Statistics Department. We are thankful to Dongho Song for extensive discussions and help with Markov switching estimation. We also benefited from useful comments by Levent Altinoglu, Kosuke Aoki, Gadi Barlevy, Susanto Basu, Fernando Broner, Bernard Dumas, Andrew Foerster, Michihiro Kandori, Nobuhiro Kiyotaki, Nan Li, Albert Martin, Kiminori Matsuyama, Masaya Sakuragawa, Joseph Stiglitz, Vincenzo Quadrini, Rosen Valchev, Jaume Ventura, and seminar participants at Bank of Canada, Bank of Japan, Boston College, Hitotsubashi University, JCER, Okayama University, Osaka University, RIETI, Shanghai Jiao Tong University, the Norwegian Business School, University of Tokyo, Waseda University, Wuhan University, and the NBER Summer Institute.

  1. *1Boston College and Espol
  2. *2University of Tokyo
  3. *3Hitotsubashi University


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