We develop a stylized model of economic growth with bubbles in which changes in investor sentiment lead to the appearance and collapse of macroeconomic bubbles or pyramid schemes. These bubbles mitigate the effects of financial frictions. During bubbly episodes, unproductive investors demand bubbles while productive investors supply them. These transfers of resources improve economic efficiency thereby expanding consumption, the capital stock and output. When bubbly episodes end, there is a fall in consumption, the capital stock and output. We argue that the stochastic equilibria of the model provide a natural way of introducing bubble shocks into business cycle models.

This paper introduces various sources of consumer heterogeneity in one-sector representative consumer (RC) growth models and develops tools to study the evolution of the distribution of consumptions, assets, and incomes. These tools are applied to the Ramsey-Cass-Koopmans model of optimal savings and the Arrow-Romer model of productive spillovers. The RC property per se places very few restrictions on the nature of observed distributions, and a wide range of distributive dynamics and income mobility patterns can arise as the equilibrium outcome. An example illustrates how to use these tools to generate quantitative predictions and compare them to the data.

We study the effects of globalization on risk sharing and welfare. Like the previous literature, we assume that governments cannot commit to enforce the repayment of debts owed by their citizens. Unlike the previous literature, we assume that governments cannot discriminate between domestic and foreign creditors when enforcing debt payments. This creates novel interactions between domestic and international trade in assets. (i) Increases in domestic trade raise the benefits of enforcement and facilitate international trade. In fact, in our set-up, countries can obtain international risk sharing even in the absence of default penalties. (ii) Increases in foreign trade raise the costs of enforcement and hamper domestic trade. As a result, globalization may worsen domestic risk sharing and lower welfare. We show how these effects depend on various characteristics of tradable goods and explore the roles of borrowing limits, debt renegotiations, and trade policy.

Conventional wisdom says that, in the absence of default penalties, sovereign risk destroys all foreign asset trade. We show that this conventional wisdom rests on one implicit assumption: that assets cannot be retraded in secondary markets. Without this assumption, foreign asset trade is possible even in the absence of default penalties. This result suggests a broader perspective regarding the origins of sovereign risk and its remedies. Sovereign risk affects foreign asset trade only if default penalties are insufficient and secondary markets work imperfectly. To reduce its effects, one can either increase default penalties or improve the working of secondary markets.