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

59 Pages Posted: 29 Apr 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, 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 boom-bust 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: Long-Plosser model, rational bubbles, non-linear DSGE models, business cycles in closed and open economies, boom-bust cycles, Dellas model

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

Suggested Citation

Kollmann, Robert, Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies (February, 2020). Globalization and Monetary Policy Institute Working Paper No. 378, Available at SSRN: https://ssrn.com/abstract=3587640 or http://dx.doi.org/10.24149/gwp378

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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France

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

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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