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Rational bubbles and the spirit of capitalism

Zhou, Ge (2013): Rational bubbles and the spirit of capitalism.

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Abstract

This paper provides a simple infinite-horizon model of rational bubbles in a production economy. The bubble can arise because of the pursuit of status, which captures the main point of "the spirit of capitalism". I illustrate that the extent of "the spirit of capitalism" determines whether a bubble can exist or not. A stronger extent leads to a larger size of the bubble. Bubbles crowd out investment and stimulate consumption, so that retard growth. I also discuss a stochastic bubble that bursts with an exogenous probability. There are actually multiple equilibria with the stochastic bubbles. At each equilibrium, bubble collapses with a probability that depends on the initial economic condition. Moreover, I demonstrate that a tax policy on wealth can both eliminate bubbles and achieve the social optimal.

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