WP Global Economy 2023.03.30
This is a working paper.
Existing models of rational pure bubble models feature multiple (and often a continuum of) equilibria, which makes model predictions and policy analysis non-robust. We show that when the interest rate in the fundamental equilibrium is below the economic growth rate (R < G), a bubbly equilibrium with R = G exists. By injecting dividends that are vanishingly small relative to aggregate income to the bubble asset, we can eliminate the fundamental steady state and resolve equilibrium indeterminacy. We show the general applicability of dividend injection through examples in overlapping generations and infinite-horizon models with or without production or financial frictions.
Keywords: bubble, dividend, equilibrium indeterminacy, growth, low interest rate.
JEL codes: D53, G12.