Ruling Out Nonstationary Speculative Bubbles

26 Pages Posted: 29 Jun 2004 Last revised: 15 Sep 2008

See all articles by Maurice Obstfeld

Maurice Obstfeld

University of California, Berkeley; Peterson Institute for International Economics; National Bureau of Economic Research; Centre for Economic Policy Research

Kenneth Rogoff

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: April 1985

Abstract

There is a large and growing empirical literature that tests forthe existence of asset-price bubbles or "sunspot" equilibria -- equilibria unrelated to market fundamentals. Our view is that even tests for non-stationary asset-price bubbles should not be interpreted as such. In the present paper we extend earlier work of ours which provided a strong case for ruling out nonstationary speculative price bubbles in models based on individual maximizing behavior. In the first part of the paper we study the possibility of stochastic exploding price-level bubbles of the kind proposed by Blanchard (1979). As in our previous work, a scheme of fractionally backing the currency with real outputis sufficient to preclude such bubbles. In the second part of the paper we examine conditions for ruling out implosive price-level bubbles, equilibrium paths along which the price level asymptotes to zero even though the monetary growth rate is constant. A condition on preference simplied by any reasonable monetary transactions technology is sufficient to prevent such bubbles from emerging. Given that anticipated future disturbances can lead to price paths which are qualitatively indistinguishable from bubble paths, and given the strong theoretical basis for ruling out nonstatioflary bubbles, our conclusion is that any "positive" evidence of bubbles should be regarded only as evidence of omitted variables.

Suggested Citation

Obstfeld, Maurice and Rogoff, Kenneth S., Ruling Out Nonstationary Speculative Bubbles (April 1985). NBER Working Paper No. w1601, Available at SSRN: https://ssrn.com/abstract=307105

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