From Asset Price Bubbles to Liquidity Traps

Abstract

This paper argues that it is useful to divide the cyclical behavior of modern mixed capitalist economies into four phases: expansion, upper turning period, recession, and lower turning period. This characterization of the business cycle is more demanding and potentially more beneficial than the one currently used by the National Bureau of Economic Research, which identifies only the peak and trough of the cycle. To illustrate the value of this approach, the recent global financial crisis is examined by reviewing the expansion driven by the development of the housing bubble. Then, the beginning of the crisis is regarded as the upper turning period. The initial financial instability evolved into a full crisis during the Great Recession due to its impact on unemployment. Finally, the ending of the crisis during the challenging period of the liquidity trap is analyzed as the lower turning period. Orthodox economic analysis offers valuable insights for both the expansion and recession phases, but can also benefit from behavioral finance and Minsky’s analysis, when fluctuations in the economy extend beyond the business cycle and become financial crises. For financial crises, the upper turning period is Minskyan and the lower turning period is an updated version of the Keynesian-Minskyan liquidity trap. Taleb’s concavity and convexity properties of the upper and lower turning periods also offer valuable insights.

Keywords: Asset Price Bubbles, Global Financial Crisis, Liquidity Trap, Business Cycles, Minsky

JEL Classification: E50, E52, E58