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

Kollmann, Robert (2020): Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies.

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: E1,E3,F3,F4, C6
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles; F - International Economics > F3 - International Finance; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance

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