A Macro and Rational Approach to Asset Price Bubbles: Definition and Early Identification in Real Time

Abstract

The topic of asset price bubbles is one of the most challenging issues facing modern central banks, yet the economics profession has not been able to work out a convincing method for identifying bubbles at an early stage and in real time. The relevant researches are either trapped in the dispute about whether bubbles have ever existed or struggling with the noises and miss-out errors which make the predictions lack sufficient confidence. This paper argues that bubbles are harmful phenomena and the task of economists is to find a way to reduce the harm. If a theory cannot find bubbles the conclusion should be that the theory has no explanatory power. Different from the conventional and the irrational approaches, this paper puts forward a macro and rational approach to bubbles, which provides an easy, early stage, real time and econometric error free identification method.