We develop a stylized model of economic growth with bubbles. In this model, changes in investor
sentiment lead to the appearance and collapse of macroeconomic bubbles or pyramid schemes.
We show how these bubbles mitigate the effects of financial frictions. During bubbly episodes,
unproductive investors demand bubbles while productive investors supply them. These transfers
of resources improve the efficiency at which the economy operates, expanding consumption, the
capital stock and output. ...
We develop a stylized model of economic growth with bubbles. In this model, changes in investor
sentiment lead to the appearance and collapse of macroeconomic bubbles or pyramid schemes.
We show how these bubbles mitigate the effects of financial frictions. During bubbly episodes,
unproductive investors demand bubbles while productive investors supply them. These transfers
of resources improve the efficiency at which the economy operates, expanding consumption, the
capital stock and output. When bubbly episodes end, these transfers stop and consumption, the
capital stock and output contract. We characterize the stochastic equilibria of the model and argue
that they provide a natural way of introducing bubble shocks into business cycle models.
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