nep-fdg New Economics Papers
on Financial Development and Growth
Issue of 2016‒08‒07
two papers chosen by
Iulia Igescu
Ministry of Presidential Affairs

  1. Are Bubbles Bad? Is a higher debt target for the Euro-zone desirable? By Coen N. Teulings
  2. Is the Macroeconomy Locally Unstable and Why Should We Care? By Franck Portier; Dana Galizia; Paul Beaudry

  1. By: Coen N. Teulings
    Abstract: Bubbles are usually viewed as a threat to financial stability. This paper takes a more nuanced view. The world economy is going through an episode of Secular Stagnation, where the equilibrium rate of return on capital r is below the growth rate of the economy g. As is well known, rational bubbles are sustainable when r?g in a steady state equilibrium. Bubbles can then implement a dynamically efficient equilibrium. We show that from a structural point of view, bubbles, Pay-As-You-Go (PAYG) pensions and sovereign debt are perfect substitutes. However, when dealing with unexpected short run fluctuations in investment, sovereign debt is far more efficient than bubbles in shifting consumption over time and in risk sharing between generations. An increase in sovereign debt is therefore an efficient response to Secular Stagnation. Instead, the current Stability and Growth Pact for the Euro-zone embarks on an opposite course.
    Keywords: bubbles, dynamic efficiency, fiscal policy, Secular Stagnation
    JEL: E44 E62
    Date: 2016–07–27
  2. By: Franck Portier (Toulouse School of Economics); Dana Galizia (Carleton University); Paul Beaudry (University of British Columbia)
    Abstract: In most modern macroeconomic models, the steady state (or balanced growth path) of the system is a local attractor in the sense that in the absence of shocks, the economy would converge to the steady state. In this paper we examine whether the times series behavior of macroeconomic aggregates (especially labor market aggregates) are in fact supportive of this locally stability view of macroeconomic dynamics or if they instead favor an alternative interpretation whereby the macro-economy may be better characterized as a locally unstable system with deterministic forces that support limit cycle behavior. To do this, we extend standard AR representations of the data to allow for smooth non-linearities using polynomials. Our main finding is that, even using a procedure which may have low power, the data provide considerable support to the view that the macro-economy may be locally unstable. An interesting finding is that the amount of non-linearity we detect in the data is rather minor but it is enough to alter the description of macroeconomic behavior. We also discuss the extent to which these two different views about the inherent dynamics of the macro-economy may matter for policy.
    Date: 2016

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