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American Economic Review Vol. 96 No. 4 2006

Speculative Growth: Hints from the U.S. Economy

Ricardo J. Caballero1; Emmanuel Farhi2; Mohamad L. Hammour3

1 Department of Economics, Massachusetts Institute of Technology, 50 Memorial Drive, Cambridge, MA 02142, and National Bureau of Economic Research. · 2 MIT, 50 Memorial Drive, Cambridge, MA02142. · 3 Capital Guidance, 44 rue Washington, 75008 Paris, France.

Abstract

We propose a framework for understanding episodes of vigorous economic expansion and extreme asset valuations. We interpret this phenomenon as a high-valuation equilibrium with a low cost of capital based on optimism about future funding. The key ingredient for such equilibrium is feedback from increased growth to a decline in the long-run cost of capital. This feedback arises when an expansion comes with technological progress in the capital sector, when fiscal rules generate procyclical fiscal surpluses, when the rest of the world has lower expansion potential or high saving needs, and when financial constraints are relaxed by the expansion itself.

DOI
10.1257/aer.96.4.1159
Volume
96
Issue
4
Pages
1159-1192
Language
en
Sources
crossref bibtex:phds-export.bib

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