Speculative Growth, Overreaction, and the Welfare Cost of Technology-Driven Bubbles

2008-08 | February 1, 2012

This paper develops a general equilibrium model to examine the quantitative effects of speculative bubbles on capital accumulation, growth, and welfare. A near-rational bubble component in the model equity price generates excess volatility in response to observed technology shocks. In simulations, intermittent equity price run-ups coincide with positive innovations in technology, investment and consumption booms, and faster trend growth, reminiscent of the U.S. economy during the late 1920s and late 1990s. The welfare cost of speculative bubbles depends crucially on parameter values. Bubbles can improve welfare if risk aversion is low and agents underinvest relative to the socially-optimal level. But for higher levels of risk aversion, the welfare cost of bubbles is large, typically exceeding one percent of annual consumption.

Article Citation

J. Lansing, Kevin. 2008. “Speculative Growth, Overreaction, and the Welfare Cost of Technology-Driven Bubbles,” Federal Reserve Bank of San Francisco Working Paper 2008-08. Available at https://doi.org/10.24148/wp2008-08

About the Author
Kevin Lansing
Kevin Lansing is a senior research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Kevin Lansing