Asset bubbles, unemployment, and financial market frictions

Abstract

We develop a tractable infinite horizon model of bubbles and unemployment. Our theoretical analysis proves that bubbles stimulate capital accumulation, reduce unemployment, and increase consumption. We then numerically investigate the impacts of credit constraints, labor market conditions, and redistribution policy on capital accumulation, unemployment, and welfare. Our numerical investigations show that the social welfare in the bubbly steady state is always greater than that in the bubbleless steady state even under the constrained-optimal policy that neutralizes externalities inherent in the model. Furthermore, we find that bubbles increase welfare to a greater extent in an economy with stricter credit constraints.