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Deflationary bubbles

By Willem H. Buiter and Anne C. Sibert

Abstract

In an attempt to clean up an unruly literature, we specify the necessary and sufficient conditions for household optimality in a model where money is the only …financial asset and provide the relevant proofs. We use our results to analyse when de‡flationary bubbles can and cannot exist. Our …findings are in contrast to the results in several prominent contributions to the literature. We argue for particular speci…cations of the no-Ponzi-game restrictions on the household’s and government’s intertemporal budget constraints in a model with money and bonds. Using the restriction on the household we derive the necessary and sufficient conditions for household optimality. The resulting equilibrium terminal conditions are then used to demonstrate that the existence of bonds does not affect when de‡flationary bubbles can and cannot occur. This result differs from that in other recent works

Topics: HB Economic Theory
Year: 2007
DOI identifier: 10.1017/S1365100506060147
OAI identifier: oai:eprints.lse.ac.uk:3323
Provided by: LSE Research Online
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