Monetary Policy, Vagabonding Liquidity and Bursting Bubbles in New and Emerging Markets: An Overinvestment View

Abstract

Capitalism without failure is like religion without sin. Charles Kindleberger's book, "Manias, Panics and Crashes", points out that speculation and crises have always been present: the world economic crisis of the 20th century, the South Sea bubble in the 18th century, and the tulip mania in the first part of the 17th century. Starting with the Japanese bubble in the 1980s we take the reader on a tour through 20 years of bubbles in emerging markets and industrial countries which have recently culminated in the 2007/08 US subprime market crisis. We explain the global stock market and real estate booms based on the real and monetary overinvestment theories of Hayek, Wicksell and Schumpeter, arguing that ample liquidity supply originating in the large industrialised countries has contributed independent from the exchange rate regime to overinvestment cycles in new and emerging markets around the globe. The policy implication is to keep interest rates not too low for too long in response to bursting bubbles.