Speculative Growth

Abstract

We propose a framework for understanding recurrent historical episodes of vigorous economic expansion accompanied by extreme asset valuations, as exhibited by Japan in the 1980's and the U.S. in the 1990's. We interpret this phenomenon as a high-valuation equilibrium with a low effective cost of capital based on optimism about the future availability of funds for investment. The key to the sustainability of such equilibrium is feedback from increased growth to an increase in the supply of funding. We show that such feedback arises naturally when the expansion is concentrated in a new economy' sector and when it is supported by sustained financial surpluses-both of which would constitute an integral part, as cause and consequence, of a speculative growth' equilibrium. The high-valuation equilibrium we analyze may take the form of a stock market bubble. In contrast to classic bubbles on non-productive assets, the bubbles in our model encourage real investments, boost long run savings, and may appear in dynamically efficient economies.