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Working Papers

February 2018, No. 18-05R

Bubbly Recessions (Revised January 2019)

Siddhartha Biswas, Andrew Hanson and Toan Phan

We develop a tractable bubbles model with financial frictions and downward wage rigidity. Competitive speculation in risky bubbles can result in excessive investment booms that precede inefficient busts, where post-bubble aggregate economic activities collapse below the pre-bubble trend. Risky bubbles can reduce ex-ante social welfare, and leaning-against-the-bubble policies that balance the boom-bust trade-off can be warranted. We further show that the collapse of a bubble can push the economy into a "secular stagnation" equilibrium, where the zero lower bound and the nominal wage rigidity constraint bind, leading to a persistent recession, such as the Japanese "lost decades."

DOI: https://doi.org/10.21144/wp18-05

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