Recurrent Bubbles and Economic Growth

Abstract

We study a regime-switching recurrent bubble model with endogenous growth. The economy experiences both bubbly and bubbleless regimes recurrently. Infinitely lived households expect future bubbles, which crowds out investment and reduces economic growth. Because realized bubbles crowd in investment, their overall impact on economic growth and welfare crucially depends on both the level of financial development and the frequency of bubbles. We examine the U.S. economic data through the lens of our model, finding evidence of recurrent bubbles. Furthermore, counterfactual simulations suggest that 1) the IT and housing bubbles together lifted U.S. GDP by almost 2 percentage points permanently; and 2) the U.S. economy could have grown even faster if people had believed that asset bubbles would not arise.