Wealth preference and rational bubbles

Abstract

In this paper, we show that rational bubbles can exist within a neoclassical economy, provided that households derive utility from holding wealth. Hence, we provide a microfoundation for bubbles that relies on a frictionless economy with an infinitely-lived representative household. While our bubbly equilibria are very similar to those obtained by Tirole (1985) in an overlapping generation economy, the underlying mechanism is fundamentally different. Instead of relying on an exchange across heterogeneous households, the bubble relies on the representative household’s willingness to accumulate wealth without the intention of spending it. Turning to public debt, we carefully review the similarities and the differences between rational bubbles and Ponzi schemes. We establish that the Ricardian equivalence must hold in any of our equilibria. Finally, within a monetary economy, we show that the preference for wealth is fundamentally different from money-in-the-utility-function.