Credit Booms, Debt Overhang and Secular Stagnation

December 2016. Revised November 2017

Wealth Preference and Rational Bubbles

We consider a neoclassical economy where households derive utility from holding wealth. We show that, under some conditions, there can be rational bubbles. Hence, we provide a microfoundation for bubbles that relies on a frictionless infitehorizon economy without any heterogeneity across households. While our bubbly equilibria are very similar to those obtained by Tirole (1985) in an overlapping generation economy, the underlying economics is different. Turning to public debt, we show that Ponzi schemes can be sustainable. Hence, in general, the limit on the accumulation of public debt by the government is not given by its no-Ponzi condition but, instead, by the representative households transversality condition. The Ricardian equivalence must hold in any of our equilibria. Finally, in the presence of money, the real equilibrium structure of the economy remains unchanged. We carefully investigate the effects of helicopter drops of money on the possibility of Ponzi schemes and of speculative hyperinflation or deflation