Asset bubbles and product market competition

Abstract

This paper studies the interplay between asset bubbles and product market competition. It offers two main insights. The first is that imperfect competition creates a wedge between interest rates and the marginal product of capital. This makes rational bubbles possible even when there is no overaccumulation of capital. The second is that when providing a production subsidy, bubbles stimulate competition and reduce monopoly rents. I show that bubbles can destroy efficient investment and have ambiguous welfare consequences. However, when they stimulate competition, they can have crowding‐in effects on capital.