Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies

60 Pages Posted: 5 Feb 2020

See all articles by Robert Kollmann

Robert Kollmann

ECARES, Université Libre de Bruxelles; University of Paris XII - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: February 4, 2020

Abstract

This paper studies rational bubbles in non-linear dynamic general equilibrium models of the macroeconomy. The term ‘Rational bubble’ refers to multiple equilibria due to the absence of a transversality condition (TVC) for capital. The lack of TVC can be due to an OLG population structure. If a TVC is imposed, the macro models considered here have a unique solution. Bubbles reflect self-fulfilling fluctuations in agents’ expectations about future investment. In contrast to explosive rational bubbles in linearized models (Blanchard (1979)), the rational bubbles in non-linear models here are bounded. Bounded rational bubbles provide a novel perspective on the drivers and mechanisms of business cycles. I construct bubbles (in non-linear models) that feature recurrent boombust cycles characterized by persistent investment and output expansions which are followed by abrupt contractions in real activity. Both closed and open economies are analyzed. In a non-linear two-country model with integrated financial markets, bubbles must be perfectly correlated across countries. Global bubbles may, thus, help to explain the synchronization of international business cycles.

Keywords: rational bubbles, boom-bust cycles, business cycles in closed and open economies, non-linear DSGE models, Long-Plosser model, Dellas model

JEL Classification: E1, E3, F3, F4, C6

Suggested Citation

Kollmann, Robert, Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies (February 4, 2020). CAMA Working Paper No. 6/2020, Available at SSRN: https://ssrn.com/abstract=3531369 or http://dx.doi.org/10.2139/ssrn.3531369

Robert Kollmann (Contact Author)

ECARES, Université Libre de Bruxelles ( email )

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University of Paris XII - Department of Economics ( email )

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Creteil cedex, 94010
France

HOME PAGE: http://www.robertkollmann.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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