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  • Research Highlights

The impact of bubbly episodes

May 1, 2023

How do economic bubbles and crashes affect long-run economic growth?

Tyler Smith

economic bubble essay

Statues of a bull and a bear, symbols of market upswings and downswings, sit outside of the entrance to the Frankfurt Stock Exchange.

Source: rissix

Economic bubbles are a persistent feature of modern economies. But the question of their impact on economic growth and how governments should respond to them remains an ongoing debate among economists, investors, and policymakers.

In a paper in the American Economic Journal: Macroeconomics , authors Pablo A. Guerron-Quintana , Tomohiro Hirano , and Ryo Jinnai take a step toward a better understanding of the long-run role asset bubbles play in the economy by building a model with recurrent bubbles, crashes, and endogenous growth and applying it to recent data from the United States. 

Their findings may help macroprudential policymakers weigh the tradeoffs between intervening to stop bubbles before they get started and cleaning them up after they burst.

Our model offers another reason to intervene and prevent bubbles, because the sheer expectation of the bubble is already a bad thing. Ryo Jinnai 

Previous macroeconomic studies have looked at recurrent asset bubbles ending up with large crashes through the lens of overlapping generation models . But there is an important limitation to this approach: households only exist for a short time in these models. This means that they do not live long enough to form expectations about bubbles. 

The authors believed that including expectations of bubble formation was crucial to capturing the role that these economic swings have on investment and economic growth. 

Introducing bubble dynamics into an endogenous growth model with long-lived households revealed some key insights into how bubbles influence households’ incentives to work, save, and consume.

First, the researchers noticed a positive crowding-in effect. Once asset bubbles appear, they make households feel richer and mitigate investors’ funding problems by speeding up capital accumulation, which in turn stimulates economic growth.

But at the same time, long-lived households see these bubbles come and go, and so expect them to happen in the future, which has a perverse, crowding-out effect. 

“If people expect bubbles to arise in the future, they think that it's okay to enjoy consumption and leisure right now rather than investing and working today,” Ryo Jinnai told the AEA in an interview. “And that is a headwind against growth.”

Whether the costs of this crowding-out effect outweighs the benefits of the crowding-in effect depends on how developed a country's financial sector is. 

When financial sectors are underdeveloped, they do a poorer job of getting funding to worthwhile projects efficiently. In that case, bubbles can actually help smooth these financial frictions by making it easier to obtain investments. However, as the financial sector develops, this problem becomes less severe, and so there is less benefit from the crowding-in effect.

The authors applied these modeling insights to US GDP and stock market data from 1984 to 2017. They were able to identify two prominent bubbles: one from 1997 to 2001, corresponding to the dot-com boom , and the other from 2006 to the onset of the Great Recession, corresponding to the housing bubble .

economic bubble essay

From this modeling exercise, the authors found that the US economy benefited from the bubble-driven economic booms. They estimated that the combination of the two bubbly episodes permanently raised the level of US GDP by about 2 percentage points. 

However, they also found that if there had been no expectations that bubbles would form at all, then the US economy would have grown even faster. The crowding-out effect of future bubbles more than outweighed the benefits of the crowding-in effect from the two bubbles.

The findings suggest that macroprudential policymakers should be more cautious about letting bubbles arise in the first place.

“Our model offers another reason to intervene and prevent bubbles, because the sheer expectation of the bubble is already a bad thing,” Jinnai said. “Financial regulations that reduce expectations of bubbles may be a good idea especially in developed economies.”

“ Bubbles, Crashes, and Economic Growth: Theory and Evidence ” appears in the April 2023 issue of the American Economic Journal: Macroeconomics .

Market rushes

How well informed are traders during a panic?

How much risk do people perceive in the global economy?

Investors have long been more cautious about stocks than seems warranted by historical data

Federal Reserve History logo

The Great Recession and Its Aftermath

Job seekers line up to apply for positions at an American Apparel store April 2, 2009, in New York City.

The period known as the Great Moderation came to an end when the decade-long expansion in US housing market activity peaked in 2006 and residential construction began declining. In 2007, losses on mortgage-related financial assets began to cause strains in global financial markets, and in December 2007 the US economy entered a recession. That year several large financial firms experienced financial distress , and many financial markets experienced significant turbulence. In response, the Federal Reserve provided liquidity and support through a  range of programs  motivated by a desire to improve the functioning of financial markets and institutions, and thereby limit the harm to the US economy. 1    Nonetheless, in the fall of 2008, the economic contraction worsened, ultimately becoming deep enough and protracted enough to acquire the label “the  Great Recession ." While the US economy bottomed out in the middle of 2009, the recovery in the years immediately following was by some measures unusually slow. The Federal Reserve has provided unprecedented monetary accommodation in response to the severity of the contraction and the gradual pace of the ensuing recovery.  In addition, the financial crisis led to a range of major reforms in banking and financial regulation, congressional legislation that significantly affected the Federal Reserve.

Rise and Fall of the Housing Market

The recession and crisis followed an extended period of expansion in US housing construction, home prices, and housing credit. This expansion began in the 1990s and continued unabated through the 2001 recession, accelerating in the mid-2000s. Average home prices in the United States more than doubled between 1998 and 2006, the sharpest increase recorded in US history, and even larger gains were recorded in some regions. Home ownership in this period rose from 64 percent in 1994 to 69 percent in 2005, and residential investment grew from about 4.5 percent of US gross domestic product to about 6.5 percent over the same period. Roughly 40 percent of net private sector job creation between 2001 and 2005 was accounted for by employment in housing-related sectors.

The expansion in the housing sector was accompanied by an expansion in home mortgage borrowing by US households. Mortgage debt of US households rose from 61 percent of GDP in 1998 to 97 percent in 2006. A number of factors appear to have contributed to the growth in home mortgage debt. In the period after the 2001 recession, the Federal Open Market Committee (FOMC) maintained a low federal funds rate, and some observers have suggested that by keeping interest rates low for a “prolonged period” and by only increasing them at a “measured pace” after 2004, the Federal Reserve contributed to the expansion in housing market activity (Taylor 2007).  However, other analysts have suggested that such factors can only account for a small portion of the increase in housing activity (Bernanke 2010).  Moreover, the historically low level of interest rates may have been due, in part, to large accumulations of savings in some emerging market economies, which acted to depress interest rates globally (Bernanke 2005). Others point to the growth of the market for mortgage-backed securities as contributing to the increase in borrowing. Historically, it was difficult for borrowers to obtain mortgages if they were perceived as a poor credit risk, perhaps because of a below-average credit history or the inability to provide a large down payment. But during the early and mid-2000s, high-risk, or “subprime,” mortgages were offered by lenders who repackaged these loans into securities. The result was a large  expansion in access to housing credit , helping to fuel the subsequent increase in demand that bid up home prices nationwide.

Effects on the Financial Sector

After home prices peaked in the beginning of 2007, according to the Federal Housing Finance Agency House Price Index, the extent to which prices might eventually fall became a significant question for the pricing of mortgage-related securities because large declines in home prices were viewed as likely to lead to an increase in mortgage defaults and higher losses to holders of such securities. Large, nationwide declines in home prices had been relatively rare in the US historical data, but the run-up in home prices also had been unprecedented in its scale and scope. Ultimately, home prices fell by over a fifth on average across the nation from the first quarter of 2007 to the second quarter of 2011. This decline in home prices helped to spark the financial crisis of 2007-08, as financial market participants faced considerable uncertainty about the incidence of losses on mortgage-related assets. In August 2007, pressures emerged in certain financial markets, particularly the market for asset-backed commercial paper, as money market investors became wary of exposures to subprime mortgages (Covitz, Liang, and Suarez 2009). In the spring of 2008, the investment bank Bear Stearns was acquired by JPMorgan Chase with the assistance of the Federal Reserve. In September, Lehman Brothers filed for bankruptcy, and the next day the  Federal Reserve provided support to AIG , a large insurance and financial services company. Citigroup and Bank of America sought support from the Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation.

The Fed’s support to specific financial institutions was not the only expansion of central bank credit in response to the crisis. The Fed also introduced a number of  new lending programs  that provided liquidity to support a range of financial institutions and markets. These included a credit facility for “primary dealers,” the broker-dealers that serve as counterparties for the Fed’s open market operations, as well as lending programs designed to provide liquidity to money market mutual funds and the commercial paper market.  Also introduced, in cooperation with the US Department of the Treasury, was the Term Asset-Backed Securities Loan Facility (TALF), which was designed to ease credit conditions for households and businesses by extending credit to US holders of high-quality asset-backed securities.

About 350 members of the Association of Community Organizations for Reform Now gather for a rally in front of the U.S. Capitol March 11, 2008, to raise awareness of home foreclosure crisis and encourage Congress to help LMI families stay in their homes.

Initially, the expansion of Federal Reserve credit was financed by reducing the Federal Reserve’s holdings of Treasury securities, in order to avoid an increase in bank reserves that would drive the federal funds rate below its target as banks sought to lend out their excess reserves. But in October 2008, the Federal Reserve gained the authority to pay banks interest on their excess reserves. This gave banks an incentive to hold onto their reserves rather than lending them out, thus mitigating the need for the Federal Reserve to offset its expanded lending with reductions in other assets. 2

Effects on the Broader Economy

The housing sector led not only the financial crisis, but also the downturn in broader economic activity. Residential investment peaked in 2006, as did employment in residential construction. The overall economy peaked in December 2007, the month the National Bureau of Economic Research recognizes as the beginning of the recession. The decline in overall economic activity was modest at first, but it steepened sharply in the fall of 2008 as stresses in financial markets reached their climax. From peak to trough, US gross domestic product fell by 4.3 percent, making this the deepest recession since World War II. It was also the longest, lasting eighteen months. The unemployment rate more than doubled, from less than 5 percent to 10 percent. 

In response to weakening economic conditions, the FOMC lowered its target for the federal funds rate from 4.5 percent at the end of 2007 to 2 percent at the beginning of September 2008. As the financial crisis and the economic contraction intensified in the fall of 2008, the FOMC accelerated its interest rate cuts, taking the rate to its effective floor – a target range of 0 to 25 basis points – by the end of the year. In November 2008, the Federal Reserve also initiated the first in a series of large-scale asset purchase (LSAP) programs, buying mortgage-backed securities and longer-term Treasury securities. These purchases were intended to put downward pressure on long-term interest rates and improve financial conditions more broadly, thereby supporting economic activity (Bernanke 2012).

The recession ended in June 2009, but economic weakness persisted. Economic growth was only moderate – averaging about 2 percent in the first four years of the recovery – and the unemployment rate, particularly the rate of long-term unemployment, remained at historically elevated levels. In the face of this prolonged weakness, the Federal Reserve maintained an exceptionally low level for the federal funds rate target and sought new ways to provide additional monetary accommodation. These included additional LSAP programs, known more popularly as quantitative easing, or QE. The FOMC also began communicating its intentions for future policy settings more explicitly in its public statements, particularly the circumstances under which exceptionally low interest rates were likely to be appropriate. For example, in December 2012, the committee stated that it anticipates that exceptionally low interest rates would likely remain appropriate at least as long as the unemployment rate was above a threshold value of 6.5 percent and inflation was expected to be no more than a half percentage point above the committee’s 2 percent longer-run goal. This strategy, known as “forward guidance,” was intended to convince the public that rates would stay low at least until certain economic conditions were met, thereby putting downward pressure on longer-term interest rates.

Effects on Financial Regulation

When the financial market turmoil had subsided, attention naturally turned to reforms to the financial sector and its supervision and regulation, motivated by a desire to avoid similar events in the future. A number of measures have been proposed or put in place to reduce the risk of financial distress. For traditional banks, there are significant increases in the amount of required capital overall, with larger increases for so-called “systemically important” institutions (Bank for International Settlements 2011a;  2011b).  Liquidity standards will for the first time formally limit the amount of banks’ maturity transformation (Bank for International Settlements 2013).  Regular stress testing will help both banks and regulators understand risks and will force banks to use earnings to build capital instead of paying dividends as conditions deteriorate (Board of Governors 2011).    

The  Dodd-Frank Act of 2010  also created new provisions for the treatment of large financial institutions. For example, the Financial Stability Oversight Council has the authority to designate nontraditional credit intermediaries “Systemically Important Financial Institutions” (SIFIs), which subjects them to the oversight of the Federal Reserve. The act also created the Orderly Liquidation Authority (OLA), which allows the Federal Deposit Insurance Corporation to wind down certain institutions when the firm’s failure is expected to pose a great risk to the financial system. Another provision of the act requires large financial institutions to create “living wills,” which are detailed plans laying out how the institution could be resolved under US bankruptcy code without jeopardizing the rest of the financial system or requiring government support.

Like the  Great Depression  of the 1930s and the  Great Inflation  of the 1970s, the financial crisis of 2008 and the ensuing recession are vital areas of study for economists and policymakers. While it may be many years before the causes and consequences of these events are fully understood, the effort to untangle them is an important opportunity for the Federal Reserve and other agencies to learn lessons that can inform future policy.

  • 1  Many of these actions were taken under Section 13(3) of the Federal Reserve Act, which at that time authorized lending to individuals, partnerships, and corporations in “unusual and exigent” circumstances and subject to other restrictions. After the amendments to Section 13(3) made by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Federal Reserve lending under Section 13(3) is permitted only to participants in a program or facility with “broad based eligibility,” with prior approval of the secretary of the treasury, and when several other conditions are met.
  • 2  For more on interest on reserves, see Ennis and Wolman (2010).

Bibliography

Bank for International Settlements. “ Basel III: A global regulatory framework for more resilient banks and banking system .” Revised June 2011a.

Bank for International Settlements. “ Global systemically important banks: Assessment methodology and the additional loss absorbency requirement .” July 2011b.

Bernanke, Ben, “The Global Saving Glut and the U.S. Current Account Deficit,” Speech given at the Sandridge Lecture, Virginia Association of Economists, Richmond, Va., March 10, 2005.

Bernanke, Ben,“Monetary Policy and the Housing Bubble,” Speech given at the Annual Meeting of the American Economic Association, Atlanta, Ga., January 3, 2010.

Bernanke, Ben, “Monetary Policy Since the Onset of the Crisis,” Speech given at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyo., August 31, 2012.

Covitz, Daniel, Nellie Liang, and Gustavo Suarez. “The Evolution of a Financial Crisis: Collapse of the Asset-Backed Commercial Paper Market.” Journal of Finance 68, no. 3 (2013): 815-48.

Ennis, Huberto, and Alexander Wolman. “Excess Reserves and the New Challenges for Monetary Policy.” Federal Reserve Bank of Richmond Economic Brief   no. 10-03 (March 2010).   

Federal Reserve System, Capital Plan , 76 Fed Reg. 74631 (December 1, 2011) (codified at 12 CFR 225.8).

Taylor, John,“Housing and Monetary Policy,” NBER Working Paper 13682, National Bureau of Economic Research, Cambridge, MA, December 2007.     

Written as of November 22, 2013. See disclaimer .

Essays in this Time Period

  • Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
  • Federal Reserve Credit Programs During the Meltdown
  • The Great Recession
  • Subprime Mortgage Crisis
  • Support for Specific Institutions

Related People

Ben S. Bernanke

Ben S. Bernanke Chairman

Board of Governors

2006 – 2014

Timothy F. Geithner

Timothy F. Geithner President

New York Fed

2003 – 2008

Related Links

  • FRASER: Text of Dodd Frank Act

Federal Reserve History

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Economic Bubble: Definition, Causes, and Examples

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What is an economic bubble? What are its causes and effects? What are some of the notable examples of this phenomenon in history?

An economic bubble is a phenomenon characterized by rapid increases in the price of assets followed by a contraction or deflation and the possible collapse of relevant markets. Hence, by this definition alone, it is an economic cycle.

Bubbles form in different types of assets such as stock markets, securities, and housing markets, as well as in business industries and sectors and economies. Take note that the phenomenon is also called asset bubble, speculative bubble, speculative mania, balloon, and market or financial bubble, among others.

There are also two types of economic bubble: equity bubble and debt bubble. An equity bubble involves high demands for tangible investments involving tangible or real assets from a legitimate market. Meanwhile, a debt bubble involves intangible or credit-based investments with minimal capability to meet growing demand in a nonexistent market

Causes and Effects of Economic Bubble

Investor behavior is the primary and general driving force behind economic bubbles. However, it is also important to highlight the fact that there is no clear agreement on what specifically causes this phenomenon.

Nonetheless, the five stages in a typical credit cycle identified by economist Hyman P. Minsky in his work on financial instability remains pretty consistent with the boom and bust patterns in bubbles. Take note of the following stages:

1. Displacement: Investors start to notice a new paradigm or more specifically, a new product or technology, or new low interest rates.

2. Boom: Prices of a particular asset start to rise at first because of a high demand for a limited supply driven by more investors entering the market.

3. Euphoria: More and more investors try to enter the market while disregarding risks because of a positive perception toward the involved asset.

4. Profit Taking: Several investors begin to cash out after realizing that the value of the asset is not really worth that much.

5. Panic: Prices of the asset suddenly plummets as more investors start to liquidate, and the availability of supply outnumbers present demand.

The review study of S. Girdzijauskas highlighted other theories or hypotheses explaining the reason behind or causes of an economic bubble. One assumption asserts that bubbles are related to inflation. Thus, the factors causing inflation could also be the same factors that cause bubbles to occur.

Another assumption is that there is a basic fundamental value to every asset, and the bubbles represent an increase or rise over that fundamental value. There are also chaotic theories arguing that the phenomenon comes from certain critical states on the market that originate from the communication of economic players.

Nevertheless, the multifaceted effects of economic bubbles can be generally understood by observing the situations transpiring in the five stages of the credit cycle identified by Minsky. For example, both the profit-taking and panic stages result in massive liquidation or perhaps, defaults that in turn, leads to deflation of asset prices.

The extent of the effects of a collapsed bubble depends on the socioeconomic influence of the involved asset. For example, the housing bubble in the U.S. resulted in the subprime mortgage crisis that further resulted in the pervasive 2007-2008 Financial Crisis that affected not only the American economy but also the entire global economy.

Notable Examples of Bubbles in History

The emergence and collapse of bubbles are regarded as a recurrent feature of modern economic history. The first recorded example of this phenomenon dated back in the 1600s during the tulip mania in The Netherlands. Below are the notable examples of economic bubble in history:

1. Tulip Mania of the 1600s

Tulips were valuable commodities in The Netherlands during the Dutch Golden Age. The trading of tulip bulbs started during the late 1590s when Dutch botanist Carolus Clusius brought the plant from the Ottoman Empire and planted them for his scientific research. The plant caught the fancy of the Dutch, and it became a hot commodity across the country, with some rare varieties becoming luxury goods.

Demands for tulips increased. The rare varieties commanded astronomical prices. The growing Dutch middle class bought them as a status symbol. French merchants fueled further the demand. Investors took notice, and they began buying tulips from local growers for eventual reselling.

Note that it took years for the plant to mature. Current supply could not keep up with the demand. However, traders found a way to sell nonexistent tulips through unregulated futures exchange in which the plant was essentially sold and bought through future contracts with no actual delivery timeline. Futures trading fueled speculative pricing further.

Prices dramatically shoot up between 1636 and 1637. A bulb from a rare variety amounted to an upscale residential property in Holland. However, they eventually collapsed in February 1637 as both buyers and investors began to realize that the value of tulips and the futures contracts were excessively and unreasonably high.

2. The Dot-Com Bubble

The years that spanned from 1994 to 2000 marked the emergence of the Internet and web-based companies. In the United States, there was excessive speculation with investors betting on the current and future viability of numerous companies ranging from online shops to communication and technologies companies.

Investors were right for a certain reason. The introduction of the web browser in 1993 made the World Wide Web possible and accessible. From 1990 to 1997, ownership of computers in American households increased from 15 percent to 35 percent. Computers became a necessity rather than a luxury. The Information Age was born around this time.

The public acceptance of computers and the Internet fueled the creation of Internet-related companies. Investors were eager to invest in any dot-com company at any valuation, especially if it had one of the Internet-related prefixes in its trade name. Note that investors range from venture capitalists and angel investors to personal investors engaged in full-time day trading.

But several problems confronted dot-com companies. Most of them incurred net operating losses because they spent heavily on marketing and advertising , not toward their consumers but their investors. Some tech companies, including telecommunications providers, fast-tracked their spending to provide next-generation Internet services and communication technology.

Nevertheless, the dot-com era marked the pervasiveness of a growth-over-profits mentality. In addition, many of these companies were focusing on attracting investors rather than introducing significant products or generating profits. Easy capital was widely accessible. However, panic eventually ensued as the market peaked. Easy capital started to dry up in 2000, and companies with millions in market capitalization became worthless in a very short amount of time.

3. The U.S. Housing Bubble

Another notable example of economic bubble in recent history was the U.S. housing bubble of 2002 to 2006 that resulted in the subprime mortgage crisis that collapsed the U.S. housing market and resulted further in the 2007-2008 Financial Crisis .

The bubble was driven by numerous factors. Among these factors was the collection of laws that made housing available to low-income Americans through subsidies and lowering of interest rates via monetary policy . Other factors include subprime mortgage, predatory lending, and other banking practices that centered on relaxing standards to make mortgages more accessible.

Banks were encouraging the public to avail mortgages because they were earning from these loans. Essentially, they were securitizing these mortgages and selling them to investors. These securities are called mortgage-backed securities or MBS. Investors deemed these a low-risk and high-return investment. Thus, demand for MBS increased, and as a response, banks made housing loans easily accessible.

On the other hand, a sizeable portion of American gave in to banks. Some of them secured mortgages to buy their own houses. Others bought properties through loans in hopes that they could sell them in the future at a higher price. However, while the properties appreciated, the income of American households did not increase significantly.

Other homeowners were also unable to pay their mortgages. The positive performance of the stock market resulted in the rise in interest rates. Essentially, homeowners could not afford their mortgages as their low introductory-rate mortgages reverted to regular interest rates. Foreclosures ensued. The banking system collapsed. Eventually, the American financial market collapsed with a series of bankruptcies of companies involved in MBS investments.

FURTHER READINGS AND REFERENCES

  • Financial Crisis Inquiry Commission. 2011. The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial Economic Crisis in the United States . ISBN: 978-0-16-087727-8. Available via PDF
  • Girdzijauskas, S., Štreimikienė, D., Čepinskis, J., Moskaliova, V., Jurkonytė, E., and Mackevičius, R. 2009. “Formation of Economic Bubbles: Causes and Possible Preventions.” Technological and Economic Development of Economy . 15(2): 267-280. DOI: 10.3846/1392-8619.2009.15.267-280
  • The Economist. 2013, October 4. “Economic History: Was Tulipmania Irrational?” The Economist . Available online
  • Wang, Z. 2007. “Technological Innovation and Market Turbulence: The Dot-Com Experience.” Review of Economic Dynamics . 10(1): 78-105. DOI: 10.1016/j.red.2006.10.001

Market Business News

What is an economic bubble? Definition and causes

An Economic Bubble , also known as a Market Bubble or Price Bubble , occurs when securities are traded at prices considerably higher than their *intrinsic value, followed by a ‘burst’ or ‘crash’, when prices tumble. The term is commonly used when talking about the property market (housing bubble).

*The intrinsic value of a security is what it is really worth , its actual worth, rather than its market price or book value.

Advancements in digital communication and trading platforms have significantly increased the speed and volume of transactions, potentially accelerating the formation and expansion of economic bubbles.

Economic Bubble

Boom-bust cycle

Economic bubbles can happen when asset prices are based on implausible views about the future. The term is often used alongside the business cycle , which is also known as a boom-bust cycle.

Bubbles are only identified in retrospect when the price of the asset drops – as it is almost impossible to determine the actual intrinsic value of something in live markets.

When there is an economic bubble, prices constantly change to a point where supply and demand can no longer set the price.

Nasdaq defines an economic bubble as:

“A market phenomenon characterized by surges in asset prices to levels significantly above the fundamental value of that asset. Bubbles are often hard to detect in real time because there is disagreement over the fundamental value of the asset.”

Experts disagree on why bubbles occur

Research suggests that bubbles can happen without any bounded rationality. While other theories suggest they are often caused by price coordination, among other factors.

The economic impact of a bubble has been the subject of debate between different schools of economic thought. Although the general consensus is that they are not beneficial, there are different opinions on just how harmful their formations and bursts are.

Mainstream economists say that bubbles are not able to be identified in advance and cannot be prevented from forming. Given this uncertainty, it is the responsibility of government authorities to wait for bubbles and address the aftermath with monetary policy and fiscal policy.

The Austrian economic school of thought views economic bubbles as having a very bad impact on the economy , because they cause misallocation of resources, thus resulting in non-optimal uses.

Too much liquidity suggested as likely cause

A possible cause of bubbles is excessive monetary liquidity in the financial system, which causes banks to engage in reckless and inappropriate lending standards, which can shake financial markets and lead to volatile asset price inflation – caused by leveraged speculation.

Behavioral finance theories suggest that cognitive biases like herd behavior and overconfidence can contribute to the inflation of economic bubbles, as investors collectively overestimate prospects and underestimate risk.

The former president of Deutsche Bundesbank, Axel A. Weber, said that “the past has shown that an overly generous provision of liquidity in global financial markets in connection with a very low level of interest rates promotes the formation of asset-price bubbles.”

Examples of economic bubbles in history

  • Florida speculative building bubble (1926)
  • Stock-market bubble of the twenties (1922–1929)
  • Poseidon bubble (1970)
  • Japanese asset price bubble (1980s)
  • 1997 Asian financial crisis (1997)
  • The Dot-com bubble (1995–2000)
  • Indian property bubble (2005)
  • British property bubble (2006)
  • Irish property bubble (2006)
  • United States housing bubble (2007)
  • Spanish property bubble (2006)
  • China stock and property bubble (2007)
  • Romanian property bubble (2008)
  • Uranium bubble of 2007
  • Rhodium bubble of 2008
  • Australian first home buyer (FHB) property bubble (2009)

Brief history

The term “economic bubble” dates back to 1720. It was first used in relation to the British South Sea bubble, a period of intense speculation that led to a major and catastrophic market crash.

In 1720, the British Parliament passed the ‘Bubble Act’ to control the proliferation of joint-stock companies, requiring them to have a royal charter—a document signed by the king or queen that outlines an organization’s objectives and legal rights.

Economic Bubbles – vocabulary and concepts

There are many compound words in the English language related to “economic bubbles.” Here are six of them, plus their meanings and how they are used in a sentence:

Economic Bubble Formation

The process by which an economic bubble begins and asset prices start to rise. Example: “Analysts are studying the current market trends to understand the economic bubble formation that seems to be taking place.”

Economic Bubble Burst

The point at which an economic bubble collapses and asset prices plummet. Example: “Investors fear the economic bubble burst, which could lead to significant financial losses.”

Economic Bubble Analysis

The examination and study of the causes, effects, and patterns of economic bubbles. Example: “Her thesis provided a comprehensive economic bubble analysis of the early 2000s technology sector.”

Economic Bubble Risk

The danger or probability of an economic bubble occurring in a market. Example: “The central bank warned of the increased economic bubble risk due to the overheated real estate market.”

Economic Bubble Impact

The effect or aftermath of an economic bubble on the broader economy. Example: “Policy makers are concerned about the long-term economic bubble impact on retirement savings.”

Economic Bubble Dynamics

The complex behaviors and factors that contribute to the growth and collapse of economic bubbles. Example: “A panel discussion on economic bubble dynamics highlighted speculative trading as a key factor.”

Video – What is an Economic Bubble?

This interesting video, from our sister channel on YouTube – Marketing Business Networ k, explains what an ‘Economic Bubble’ is using simple and easy-to-understand language and examples.

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Economics of Speculative Bubbles

Last updated 3 Mar 2023

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In this revision video we look at the economics of speculative bubbles in financial markets.

A bubble exists when the market price of something is driven well above what it should be, usually due to the herd behaviour of consumers / investors especially in financial markets.

Good examples to quote in exams of speculative bubbles

•TULIP BUBBLE IN THE 17TH CENTURY

•GOLD RUSHES IN THE LATE 19TH CENTURY

•REAL ESTATE (HOUSING) BUBBLES

•DOT COM BOOM FROM 1997-2000

•JAPANESE PROPERTY AND EQUITY BUBBLE

•CRYPTO-CURRENCIES

Five stages of a speculative bubble

  • Displacement stage – excitement grows about a new product / emerging technology
  • Prices boom as demand surges + limited (inelastic) supply causing market prices to spike higher
  • Euphoria as more investors look to take advantage (Robert Shiller calls this “irrational exuberance”)
  • Profit taking stage – some investors sell as they realise prices are out of line with fundamentals
  • Panic – the herd mentality switches to desperate selling and prices fall fast inflicting big losses

Herd behaviour in financial markets

  • Herd behaviour is a phenomenon in which individuals act collectively as part of a group, often making decisions as a group that they would not make as an individual.
  • Social pressure to conform - individuals want to be accepted – and this means behaving in the same way as others, even if that behaviour goes against your natural instincts.
  • Individuals find it hard to believe that a large group could be wrong and follow the group’s behaviour in the mistaken belief that the group knows something an individual doesn’t.
  • This is described as the bandwagon effect or group think

The hot hand fallacy and over-confidence

  • This is a behavioural bias where someone believes that they are less at risk of a negative event happening to them compared to the rest of the population.
  • Traders in financial markets who have made big profits might then under-estimate the probability / risk of a downturn in share prices.
  • The hot hand fallacy in short means "whatever is currently happening will continue to happen forever.”
  • Traders in financial markets become over-confident, have mistaken valuations and believe them too strongly. Investors credit their own talents and abilities for past successes.

Prospect theory and speculative bubbles

  • A theory of human behaviour under uncertainty
  • As a market goes up, people become less risk averse and become more willing to gamble
  • This accelerates the rate of increase of asset prices
  • Investors also suffer from loss aversion
  • When asset prices start falling, many are initially reluctant to sell because that might crystalize a loss
  • They hold on their investments for too long – before panic selling sets in and prices fall rapidly

What are the main causes of speculative bubbles in financial markets?

Speculative bubbles in financial markets occur when the prices of assets become detached from their fundamental values due to excessive investor optimism and buying activity. This can happen due to a variety of reasons, including:

  • Herding behavior : When investors follow the crowd and invest in assets simply because others are doing so, without considering their fundamental values.
  • Easy credit : When interest rates are low and credit is easily available, investors may take on more debt to invest in assets, driving up prices.
  • Overconfidence : When investors become overconfident in their ability to predict future prices and ignore the risks associated with their investments.
  • Speculative mania: When investors become caught up in the excitement of a particular asset, such as a new technology or a trendy investment, and invest in it without regard for its actual value.
  • Market manipulation : When traders or institutions use illegal tactics such as insider trading or price manipulation to artificially inflate prices.

Some examples of speculative bubbles in financial markets include:

  • Dot-com bubble (1995-2001) : A period of excessive speculation in internet-related stocks that led to a sharp increase in stock prices followed by a collapse in 2000-2001.
  • Housing bubble (2002-2007) : A period of rapid expansion in the U.S. housing market, driven by easy credit and speculation, which eventually led to the 2008 global financial crisis.
  • Tulip mania (1637): An early example of a speculative bubble, where the prices of tulip bulbs in the Netherlands soared to absurd levels before collapsing and causing significant economic damage.
  • Bitcoin bubble (2017): A period of rapid growth in the value of the cryptocurrency Bitcoin, driven by speculation and hype, which eventually led to a steep price correction in early 2018.

It's important to note that while speculative bubbles can generate significant returns in the short term, they often lead to significant losses in the long run. Therefore, it's crucial for investors to carefully consider the fundamentals of an asset before investing and to avoid getting caught up in market hype and speculation.

  • Speculative Bubble
  • Asset Price Bubble
  • Financial stability
  • Financial market
  • Financial instability

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The economy's gone from strength to strength after the pandemic — but no one quite knows why, or what comes next

  • America has gone from a pandemic crash and recession fears to stocks at record highs and an economic boom.
  • Lockdowns, wars, shortages, inflation, interest rates, day trading, and AI have all played a role.
  • Here's a look at how we got here — and what might be coming next.

Insider Today

We've been on a strange journey over the past four years.

First there was a deadly pandemic that crashed financial markets and tanked the economy, then spiraling inflation and surging interest rates that squeezed households and roiled industries, and now stock markets at record highs and no recession in sight.

So how did we get here — and what lies ahead in 2024 for the US economy?

Going viral

The COVID-19 pandemic struck in early 2020, spurring widespread lockdowns, travel restrictions, and shuttering businesses.

Global supply chains quickly became snarled by mass closures in countries like China, shipping delays, clogged ports, labor shortages, and other headaches caused by the virus and measures to stem its spread.

Frightened investors dumped stocks in droves , sending the S&P 500 down by a third in just over a month. The shutdown of large swathes of the economy meant GDP contracted by 8% in a single quarter. Unemployment surged from 3.5% to nearly 15%, and remained above 10% for four consecutive months.

The Federal Reserve rushed to shore up the economy by slashing its benchmark interest rate from upwards of 1.5% to between zero and 0.25%. It also ramped up its bond purchases to inject more cash into the economy.

Similarly, the US government scrambled to help by mailing stimulus checks to households, offering generous loans and grants to ailing businesses, and rolling out a raft of emergency-spending programs.

The panic quickly faded on Wall Street, and institutions raced to scoop up bargains. There was also an explosion in day trading that continued throughout 2021, fueled by people being stuck at home with limited leisure options but stimulus checks to spend, along with the rise of zero-commission trading apps such as Robinhood and forums including WallStreetBets that encouraged risky trading for the entertainment value.

The upshot was that casual investors flooded into meme stocks, cryptocurrencies, special-purpose acquisition companies (SPACs), and other highly speculative assets.

Some wanted to make a quick buck. Others were eager to thumb their noses at hedge funds and the like, or ride to the rescue of GameStop, AMC Entertainment, and other heavily shorted companies they remembered fondly from their childhoods.

Many Americans also socked away money during the pandemic, as they saved on expenses like travel and live entertainment.

War, prices, and rates

Fast forward to the spring of 2022, and Russia's invasion of Ukraine delivered a fresh shock to global supply chains, causing essentials like food and energy to surge in price.

Stimulus-fueled demand, combined with pandemic and war-related supply disruptions, caused inflation to spike to a 40-year high of 9.1% in June that year.

The Fed swiftly raised interest rates to rein in the price growth, lifting them from virtually zero to upward of 5% in under 18 months, and hasn't touched them since.

Higher rates typically curb spending, investing, and hiring, which can lead to unemployment jumping and the economy slowing so much that a recession takes hold.

They also tend to pull down the prices of risky assets like stocks and real estate. That's because they bolster the ultra-safe yields from Treasury bonds and savings accounts, leading investors to swap potential returns for a guaranteed payday.

Financial pain builds

American households faced a double whammy of soaring food, fuel, and housing costs as inflation took off, along with surging monthly payments on their mortgages, car loans, credit cards, and other debts as rates rose.

As a result, they began cracking open their pandemic nest eggs, racking up record amounts of credit-card debt, and putting away less money each month.

That trend threatened to result in consumers running short of cash and spending less on goods and services. At the same time, companies were dealing with larger interest payments on their debts, cost inflation, labor shortages, and other problems.

The housing market also ground to a halt last year after mortgage rates jumped above 7% for the first time in more than two decades. Prospective sellers held off on listing their homes as they didn't want to give up the low rates they'd locked in. Potential buyers balked at paying top dollar for a home and coughing up a much larger monthly payment than they expected.

Silicon Valley Bank was one of several smaller lenders last spring to be caught off-guard by the rate hikes, which triggered large paper losses in its portfolio of bonds and mortgages.

Depositors, spooked by the declines and fearful of losing their money, frantically withdrew their cash, causing the banks to collapse and prompting the federal government to take them over and guarantee their deposits.

Higher rates, combined with the shift to remote work, have also hammered the value of offices and other commercial real estate.

The industry now faces a triple threat of declining property values, a credit crunch as embattled regional banks pull back from financing the sector, and onerous interest payments for debt-reliant developers poised to refinance at much higher rates.

Defying the doomsayers

Despite all those headwinds, the US economy grew by a solid 3.3% last quarter on an annualized basis, unemployment remained at a historically low 3.7% in January, and inflation has dropped below 4% in recent months.

Consumer spending and company profits have also held up, defying concerns of a demand slump and an earnings recession.

There's also widespread excitement about AI's potential to supercharge productivity . In addition, the Fed has signaled it will pivot to cutting rates this year, easing pressure on sectors such as banking and real estate while also reducing the risk of a recession.

Against that rosy backdrop , it's little wonder that the S&P 500 has climbed 5% this year to a record high of over 5,000 points, after soaring 24% in 2023.

It's still unclear why exactly America is seemingly thriving, when other countries like the UK are facing stickier inflation and have slumped into recession .

The surge in prices may truly have been transitory , a product of the pandemic driving up demand for goods at a time when supply chains couldn't deliver them.

Or inflation might be the result of growth in the money supply, and its decline last year has set the stage for an economic downturn .

Massive government outlays in the form of stimulus checks, student-debt relief, and infrastructure and technology programs may have propped up growth and employment, forestalling a recession.

Advances in AI may have multiplied the value of the "Magnificent Seven" stocks and pulled the entire market higher, or the tech might be overblown and a bubble destined to burst .

In short, everything might be hunky-dory and the good times will just keep rolling. Alternatively, years of hype, speculation and irrational exuberance combine with unsustainable amounts of spending and borrowing in both the private and public sectors to doom the stock market and economy to disaster.

While nobody can be certain what's coming, understanding how we got here may help us understand the potential risks ahead.

economic bubble essay

Watch: Henry Blodget: This could be exactly what the start of a major correction looks like

economic bubble essay

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  • U.S. & Canada

3 things could pop megacap stock bubble — and ‘weigh heavily’ on broader market

William watts, s&p 500 will suffer when concentrated megacap rally comes undone: oxford economics, what would bubble trouble mean for the broader market.

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If the megacap tech rally is indeed a bubble, how might it end?

Megacap technology shares remain in the driver’s seat as the stock market extends a narrowly led bull run into 2024, leading to an intensifying debate over whether the rally carries echoes of the 1990s tech bubble.

“The ‘Magnificent Seven’ continue to drive U.S. equities higher, pushing index concentration to record levels. A reversal in their fortunes could weigh heavily on the overall market,” Daniel Grosvenor, director of equity strategy at Oxford Economics, said in a Monday note.

Counterpoint: Stock-market investors fear a megacap meltdown. Here’s what history says.

The so-called Magnificent Seven — Nvidia Corp. NVDA, +16.40% , Alphabet Inc. GOOG, +1.03% GOOGL, +1.08% , Amazon.com Inc. AMZN, +3.55% , Apple Inc. AAPL, +1.12% , Tesla Inc. TSLA, +1.36% , Meta Platforms Inc. META, +3.87% and Microsoft Corp. MSFT, +2.35% — captured investors’ attention and dominated returns in 2023 on expectations they would be the biggest beneficiaries of an artificial-intelligence boom. In 2024, Apple (down 6.2% year to date) and Tesla (down nearly 33%) have stumbled, while leadership of the overall stock-market rally has grown only more concentrated.

Read: Nvidia’s stock heads for biggest drop in over a year and biggest market-cap loss ever

So how concentrated is the market? Grosvenor noted that after beating the broader S&P 500 SPX benchmark by almost 30% in 2023, the top 10 constituents of the index have outperformed by another 3% so far in 2024. Superior earnings growth over the past year has underpinned the megacap top performers, who have seen momentum largely continue in 2024.

See: Three stocks of AI ‘enablers’ to consider as Nvidia sets up another possible surprise

The top 10 now make up 32% of total S&P 500 market capitalization, around 6 percentage points higher than the weight of the top-10 stocks at the peak of the 1990s dot-com bubble, Grosvenor observed (see chart below).

The bulk of the top 10 is accounted for by the Magnificent Seven, though Eli Lilly & Co. LLY, +3.18% recently surpassed Tesla’s market cap, Grosvenor noted, warning that the dominance of such a small number of companies and the high degree of correlation between them reduces the benefits of index diversification and means a downturn in their fortunes could weigh heavily on the overall market.

Moreover, he noted a tendency for index concentration to revert to the mean, though the relationship appears “relatively weak over a short time horizon” and requires a catalyst to spark the reversal.

So where might that catalyst come from? Grosvenor laid out some possible candidates:

Earnings expectations

While the megacap companies continue to see strong earnings growth overall, widening the gap with the rest of the market, it will likely prove harder for them to beat analysts’ expectations this year, Grosvenor said.

After easily topping last year’s expectations for 10% earnings growth, the Magnificent Seven are expected to deliver a further 22% rise in 2024 on the assumption profit margins will move to a record high. The analyst is skeptical, arguing that while AI advances might help further boost profitability in the medium term, a lot of upside already appears baked in.

“This leaves room for disappointment,” Grosvenor wrote, noting that history suggests it takes a long time to see the benefits of technological change and that there’s no guarantee “these particular companies will be the ultimate winners.”

Related: AI hype around ‘Magnificent 7’ stocks is latest example of ‘big market delusion’

Stretched valuations vs. rising bond yields

Grosvenor argued that valuations for the Magnificent Seven are looking stretched again, with the group now trading at an average 12-month forward price-to-earnings ratio of 29, compared with 16 for the rest of the S&P 500 — well above the decade average and now topping its postpandemic average.

That’s happened despite bond yields being well above their average, something which tends to weigh on stocks whose lofty valuations are based on expectations for earnings far into the future. That makes this part of the market vulnerable to a correction if inflation proves stickier than expected and bond yields continue to rise in the near term, he argued.

Grosvenor noted that the Magnificant Seven underperformed alongside the initial sharp jump in Treasury yields in 2022 and struggled to beat the wider market in the third quarter of last year when yields spiked, despite their strong earnings performance.

Policy uncertainty

A contentious U.S. presidential election also looms in November, heightening the prospect of “policy uncertainty” that could be particularly unsettling to the high-flying stocks.

Grosvenor notes the tech sector remains under the spotlight from an antitrust perspective, which will likely be a key campaign emphasis for Democrats on the campaign trail.

The Magnificent Seven could also be exposed to an increase in uncertainty over trade policy, he said, noting that as a group they generate a much higher proportion of their revenues outside of the U.S. than the broader S&P 500. They also have meaningful exposure to China and Taiwan and, in recent years, their relative returns have had a negative correlation with measures of trade uncertainty (see chart above).

Don’t miss: Nvidia’s earnings report could kill the momentum driving U.S. stocks higher, regardless of how it turns out.

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About the Author

economic bubble essay

William Watts is MarketWatch markets editor. In addition to managing markets coverage, he writes about stocks, bonds, currencies and commodities, including oil. He also writes about global macro issues and trading strategies. During his time at MarketWatch, Watts has served in key roles in the Frankfurt, London, New York and Washington, D.C., newsrooms.

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Guest Essay

When Your Technical Skills Are Eclipsed, Your Humanity Will Matter More Than Ever

A graphic depicting a door being opened to  reveals a handshake, a cup of a coffee, a briefcase and a swirl of colors.

By Aneesh Raman and Maria Flynn

Mr. Raman is a work force expert at LinkedIn. Ms. Flynn is the president of Jobs for the Future.

There have been just a handful of moments over the centuries when we have experienced a huge shift in the skills our economy values most. We are entering one such moment now. Technical and data skills that have been highly sought after for decades appear to be among the most exposed to advances in artificial intelligence. But other skills, particularly the people skills that we have long undervalued as soft, will very likely remain the most durable. That is a hopeful sign that A.I. could usher in a world of work that is anchored more, not less, around human ability.

A moment like this compels us to think differently about how we are training our workers, especially the heavy premium we have placed on skills like coding and data analysis that continue to reshape the fields of higher education and worker training. The early signals of what A.I. can do should compel us to think differently about ourselves as a species. Our abilities to effectively communicate, develop empathy and think critically have allowed humans to collaborate, innovate and adapt for millenniums. Those skills are ones we all possess and can improve, yet they have never been properly valued in our economy or prioritized in our education and training. That needs to change.

In today’s knowledge economy, many students are focused on gaining technical skills because those skills are seen as the most competitive when it comes to getting a good job. And for good reason. For decades, we have viewed those jobs as future-proof, given the growth of technology companies and the fact that engineering majors land the highest-paying jobs .

The number of students seeking four-year degrees in computer science and information technology shot up 41 percent between the spring of 2018 and the spring of 2023, while the number of humanities majors plummeted. Workers who didn’t go to college and those who needed additional skills and wanted to take advantage of a lucrative job boom flocked to dozens of coding boot camps and online technical programs.

Now comes the realization of the power of generative A.I., with its vast capabilities in skills like writing, programming and translation. (Microsoft, which owns LinkedIn, is a major investor in the technology.) LinkedIn researchers recently looked at which skills any given job requires and then identified over 500 likely to be affected by generative A.I. technologies. They then estimated that 96 percent of a software engineer’s current skills — mainly proficiency in programming languages — can eventually be replicated by A.I. Skills associated with jobs like legal associates and finance officers will also be highly exposed.

In fact, given the broad impact A.I. is set to have, it is quite likely to affect all of our work to some degree or another.

We believe there will be engineers in the future, but they will most likely spend less time coding and more time on tasks like collaboration and communication. We also believe that there will be new categories of jobs that emerge as a result of A.I.’s capabilities — just like we’ve seen in past moments of technological advancement — and that those jobs will probably be anchored increasingly around people skills.

Circling around this research is the big question emerging across so many conversations about A.I. and work, namely: What are our core capabilities as humans?

If we answer that question from a place of fear about what’s left for people in the age of A.I., we can end up conceding a diminished view of human capability. Instead, it’s critical for us all to start from a place that imagines what’s possible for humans in the age of A.I. When you do that, you find yourself focusing quickly on people skills that allow us to collaborate and innovate in ways technology can amplify but never replace. And you find yourself — whatever the role or career stage you’re in — with agency to better manage this moment of historic change.

Communication is already the most in-demand skill across jobs on LinkedIn today. Even experts in A.I. are observing that the skills we need to work well with A.I. systems, such as prompting, are similar to the skills we need to communicate and reason effectively with other people.

Over 70 percent of executives surveyed by LinkedIn last year said soft skills were more important to their organizations than highly technical A.I. skills. And a recent Jobs for the Future survey found that 78 percent of the 10 top-employing occupations classified uniquely human skills and tasks as “important” or “very important.” These are skills like building interpersonal relationships, negotiating between parties and guiding and motivating teams.

Now is the time for leaders, across sectors, to develop new ways for students to learn that are more directly, and more dynamically, tied to where our economy is going, not where it has been. Critically, that involves bringing the same level of rigor to training around people skills that we have brought to technical skills.

Colleges and universities have a critical role to play. Over the past few decades, we have seen a prioritization of science and engineering, often at the expense of the humanities. That calibration will need to be reconsidered.

Those not pursuing a four-year degree should look for those training providers that have long emphasized people skills and are invested in social capital development.

Employers will need to be educators not just around A.I. tools but also on people skills and people-to-people collaboration. Major employers like Walmart and American Airlines are already exploring ways to put A.I. in the hands of employees so they can spend less time on routine tasks and more time on personal engagement with customers.

Ultimately, for our society, this comes down to whether we believe in the potential of humans with as much conviction as we believe in the potential of A.I. If we do, it is entirely possible to build a world of work that not only is more human but also is a place where all people are valued for the unique skills they have, enabling us to deliver new levels of human achievement across so many areas that affect all of our lives, from health care to transportation to education. Along the way, we could meaningfully increase equity in our economy, in part by addressing the persistent gender gap that exists when we undervalue skills that women bring to work at a higher percentage than men.

Almost anticipating this moment a few years ago, Minouche Shafik, who is now the president of Columbia University, said: “In the past, jobs were about muscles. Now they’re about brains, but in the future, they’ll be about the heart.”

The knowledge economy that we have lived in for decades emerged out of a goods economy that we lived in for millenniums, fueled by agriculture and manufacturing. Today the knowledge economy is giving way to a relationship economy, in which people skills and social abilities are going to become even more core to success than ever before. That possibility is not just cause for new thinking when it comes to work force training. It is also cause for greater imagination when it comes to what is possible for us as humans not simply as individuals and organizations but as a species.

Aneesh Raman is a vice president and work force expert at LinkedIn. Maria Flynn is the president of Jobs for the Future.

The Times is committed to publishing a diversity of letters to the editor. We’d like to hear what you think about this or any of our articles. Here are some tips . And here’s our email: [email protected] .

Follow the New York Times Opinion section on Facebook , Instagram , TikTok , X and Threads .

An earlier version of this article misstated the group surveyed in a poll on worker skills. The respondents were executives in the United States, not executives at LinkedIn.

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  • The Summary of Economic Bubbles

The Summary of Economic Bubbles - Essay Example

The Summary of Economic Bubbles

  • Subject: English
  • Type: Essay
  • Level: Masters
  • Pages: 1 (250 words)
  • Downloads: 2
  • Author: hanehans

Extract of sample "The Summary of Economic Bubbles"

Summary of Article “Economic Bubbles” Economic bubble is a term used to define the trade of products and assets at highly inflated prices that are considerably beyond the assets intrinsic value. Economic bubbles are formed as a result of speculation by the investors who feel very optimistic about the future increase in the asset’s price. These investors realize the fact that a drastic increase in price of a product will encourage its owners to sell it, and at the same time its aggregate supply in the market will increase, both of these result in decline of prices and eventually this boom becomes a crash or a burst.

Economic bubbles are formed because the investors respond positive to the increasing price, i.e., they buy more with the increasing prices. This may be due to greed or a desire to become rich by selling those assets at an even higher price in the near future. In other words, buyers tend to assume that they will be able to find another buyer (sometimes referred to as “a greater fool”) who will pay them even more than they paid for the asset. These bubbles cause a little or no economic damage because usually the “greater fools” get wiser by learning from their failure and the sellers get a lot richer.

However, its effects can be felt if owners of inflated assets assume themselves as rich and start spending unwisely by getting more bank loans against their overpriced assets as securities. So when the prices of the overpriced assets fall, both the loan recipient and the bank could bankrupt and suffer huge losses. On a macro level several banks may fail and lesser money is available for investments to recover the economy. Similarly when this happens due to speculation of the share prices of the company, the stock markets may eventually crash.

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Jeremy Grantham says the AI bubble will burst and take the stock market down with it. Here are his 14 best quotes from an event this week.

  • Jeremy Grantham issued warnings about stocks, real estate, and the economy this week.
  • The elite investor predicted the AI bubble would pop, bringing down the stock market with it.
  • Grantham slammed the Fed for creating asset bubbles, and flagged climate change as a key concern.

Insider Today

Jeremy Grantham rang the alarm on a sprawling real estate bubble, warned US stocks are heavily overvalued and could disappoint for the next decade, and declared the booming American economy is divorced from reality.

The GMO cofounder and long-term investment strategist predicted the AI frenzy would fizzle and take down the stock market with it.

The market historian also tore into the Federal Reserve for repeatedly inflating asset bubbles, and reeled off climate change, dwindling resources, and population decline as critical long-term threats.

Grantham made the striking comments at the Exchange conference in Miami this week. Here are his 14 best quotes from the event, lightly edited for length and clarity:

1. "The surprising thing about this entire event is how US it is. In real estate, everything everywhere is in a dangerous bubble . But in equities, for some reason, they left out the rest of the world."

2. "There has never been a sustained bull market starting from a Shiller price-to-earnings ratio of 33 — it's in the top 2% of the historical range. There's never been a sustained rally starting from full employment. If you want to have a long, impressive rally, you want to see profit margins down, unemployment up, and PEs low."

3. "The higher the price, the lower the return. Starting with very high prices is pretty much a guarantee that for the next 10 or 15 years, you will be disappointed. You never do well for a long time when you start when everything is rosy. That seems pretty obvious, doesn't it guys?"

'Shovels in the gold rush'

4. "There's never been a situation where you had a bubble of considerable dimensions — one of the three great bubbles in American history — where it's been interrupted by a secondary, very focused bubble of a different kind — of artificial intelligence."

5. "We were unraveling quite nicely by historical standards, until that infamous day when they came out with ChatGPT. AI completely scrambled what was a relatively well-behaved event, and set off initially 10 months of amazing rally by a couple of handfuls of stocks . The rest of the market, with its jaw hanging loose, watched as these guys went up 50%, 60%, 70%. Then 10, or 11 weeks ago, the rest of the market gave up waiting patiently, and joined in."

6. "Everyone is ordering these darn chips to facilitate AI. They don't know what they're going to use the chips for yet. It's like selling shovels in the gold rush, and the shovel sellers are completely freaking out."

7. "The bad news for a bear is I can't easily dismiss artificial intelligence. What I think will happen is we'll have that euphoria, like we had in railroads and the internet, and then we will have the setback that followed every single case."

'Living on air'

8. "We're way over our skis. When that subsidiary bubble breaks, will it take the air out of the rest of the market , who will then do maybe what they would have done anyway? That's my bet."

9. "Usually rallies end when you've had a long run — check; full employment — check. We're seeing the conditions when these things end."

10. "The same with the economy, it's been living on air . How on earth can we have employment numbers that are three times the long-term trend in the population, in the labor force? It is quite remarkable, and the rest of the world is not participating."

11. "Quality is the longest market inefficiency in history. AAA stocks don't go bust as much, they do better in bear markets, and yet they have returned on average an extra half a percentage point annually for almost 100 years."

'Non-stop catastrophes'

12. "My personal feeling on the Fed has always been that they get almost nothing right ."

(Grantham blasted Alan Greenspan, the Fed's chair during the dot-com bubble, as the "biggest nitwit of all" for inflating the prices of stocks and housing with loose monetary policy. He slammed Greenspan's successor, Ben Bernanke, for blowing up the mid-2000s housing bubble in the same way.)

13. "Both resources and climate change have just been smashed; they are incredibly cheap. They are really long-term interesting, but volatile and hair-raising groups, both of them."

14. "We are just having non-stop catastrophes . Climate change is damaging our ability to generate wealth, to grow reasonably priced food. We're running out of resources at a time of climate change, growing toxicity, and problems with health, but above all fertility."

economic bubble essay

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  2. The Bubble Economy Free Summary by Robert U. Ayres

    economic bubble essay

  3. What is an Economic Bubble? Meaning, Phases and Examples

    economic bubble essay

  4. Economic Bubble

    economic bubble essay

  5. What is an economic bubble? Definition and causes

    economic bubble essay

  6. Understanding Economic Bubbles

    economic bubble essay

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  1. PDF Bubbles, Crashes, and Economic Growth: Theory and Evidence

    An asset bubble may emerge when the economy switches to the bubbly regime. Under some conditions, we show that there exists an equilibrium in which asset bubbles emerge and collapse recurrently as the economy switches back and forth between the two regimes. Theoretically, recurrent bubbles produce two competing e ects in our framework. First, bub-

  2. What Is an Economic Bubble and How Does It Work, With Examples

    A bubble is an economic cycle that is characterized by the rapid escalation of market value, particularly in the price of assets. This fast inflation is followed by a quick decrease in value,...

  3. Economic bubble

    An economic bubble (also called a speculative bubble or a financial bubble) is a period when current asset prices greatly exceed their intrinsic valuation, being the valuation that the underlying long-term fundamentals justify.

  4. 5 Stages of a Bubble

    A financial bubble, also known as an economic bubble or an asset bubble, is characterized by a fast, large climb in the market price of different assets. ... These include white papers, government ...

  5. PDF Economic Growth with Bubbles

    Why are they unpredictable? How do bubbles affect consumption, investment and productivity growth? In a nutshell, the goal of this paper is to develop a stylized view or model of economic growth with bubbles. The theory presented here features two idealized asset classes: productive assets or "capital" and pyramid schemes or "bubbles".

  6. American Economic Association

    paper in the American Economic Journal: Macroeconomics, authors Pablo A. Guerron-Quintana, Tomohiro Hirano, and Ryo Jinnai take a step toward a better understanding of the long-run role asset bubbles play in the economy by building a model with recurrent bubbles, crashes, and endogenous growth and applying it to recent data from the United States.

  7. For What It's Worth: Historical Financial Bubbles and the Boundaries of

    Abstract This essay is a historical and epistemological exploration of a traditionally crazy economic event: the financial bubble. Venturing into two different moments in the history of economic thinking, it investigates financial bubbles as epistemic frontiers, where rationality has reached its limits. The first half forays into late twentieth-century economics. Since 1980, an interpretive ...

  8. Bubbles, Crashes, and Economic Growth: Theory and Evidence

    The fundamental regime is characterized by the absence of bubbles (bubbleless economy), in which investors are unable to obtain funds as they wish because of ... 2 The same applies to the landmark papers on rational bubbles in an overlapping generations model, e.g., Samuelson (1958); Shell, Sidrauski, and Stiglitz (1969, section 3(1980); Tirole ...

  9. PDF Bubbles and Stagnation

    ation target. In that case, no bubble equilibria exist and the economy settles at a fundamental equilibrium, possibly a stagnation trap if the ZLB binds. While safe bubbles are more likely to avoid stagnation, the lower interest rates associated with risky bubbles loosen borrowing constraints, which can improve welfare when nancing constraints

  10. Formation of economic bubbles: Causes and possible preventions

    The cause of bubbles remains a challenge to economic theory. The main idea behind the creation of economic bubbles is a weak financial policy and excessive monetary liquidity in the financial system (Topol 1991). When interest rates are going down, investors tend to avoid putting their capital into savings accounts.

  11. The Great Recession and Its Aftermath

    The period known as the Great Moderation came to an end when the decade-long expansion in US housing market activity peaked in 2006 and residential construction began declining. In 2007, losses on mortgage-related financial assets began to cause strains in global financial markets, and in December 2007 the US economy entered a recession.

  12. Economic Bubble: Definition, Causes, and Examples

    An economic bubble is a phenomenon characterized by rapid increases in the price of assets followed by a contraction or deflation and the possible collapse of relevant markets. Hence, by this definition alone, it is an economic cycle. Bubbles form in different types of assets such as stock markets, securities, and housing markets, as well as in ...

  13. PDF Bubbles, Financial Crises, and Systemic Risk

    that formed during the run-up (or bubble) phase were fueled by credit. The reason is that the bursting of credit bubbles leads to more de-leveraging and stronger ampli - cation mechanisms. For example, while the bursting of the technology bubble in 2000 caused signi cant wealth destruction, its impacts on the real economy were relatively

  14. What is an economic bubble? Definition and causes

    An Economic Bubble, also known as a Market Bubble or Price Bubble, occurs when securities are traded at prices considerably higher than their *intrinsic value, followed by a 'burst' or 'crash', when prices tumble.The term is commonly used when talking about the property market (housing bubble). *The intrinsic value of a security is what it is really worth, its actual worth, rather than ...

  15. inside reading 4, 6- economic bubbles

    6- economic bubbles. An economic bubble occurs when speculation in commodities (such as oil), securities (such as stocks and bonds), real estate, or collectibles drives up prices well beyond the item's Intrinsic value. The end result of this boom in price is a crash or bust. The price falls sharply once it becomes clear that it is far beyond ...

  16. Economics of Speculative Bubbles

    A bubble exists when the market price of something is driven well above what it should be, usually due to the herd behaviour of consumers / investors especially in financial markets. Good examples to quote in exams of speculative bubbles. •TULIP BUBBLE IN THE 17TH CENTURY. •GOLD RUSHES IN THE LATE 19TH CENTURY. •REAL ESTATE (HOUSING) BUBBLES.

  17. Economy's Gone From Pandemic Crash to Dodging Recession, Stocks at

    Theron Mohamed. Feb 20, 2024, 2:21 AM PST. The S&P 500 has hit record highs this year. Getty Images. America has gone from a pandemic crash and recession fears to stocks at record highs and an ...

  18. Effects Of The Bubble Economy On The Economy

    The Bubble Economy An economic bubble is when "the price for an asset exceeds its fundamental value by a large margin. During an economic bubble, prices for a financial asset or asset class are highly inflated, bearing little relation to the intrinsic value of the asset (Investopedia Staff, 2010)."

  19. Impact of an Economic Bubble

    An economic bubble has been defined as a period of time in an economy, where prices strongly vary from the average normal daily prices. While researching the topic of economic bubbles and their specific effects on the Global economy, I found multiple different viewpoints and information.

  20. Why the latest stock market bubble isn't like others we've seen before

    Markets have surged, but the rally hasn't been accompanied by high and rising leverage like previous bubbles in 1929 or 2008, Capital Economics said. Markets have surged, but the rally hasn't been ...

  21. Opinion

    Many Americans Believe the Economy Is Rigged. Feb. 21, 2024. Damon Winter/The New York Times. 1506. By Katherine J. Cramer and Jonathan D. Cohen. Ms. Cramer is co-chair of the Commission on ...

  22. What Bubble? Nvidia Profits Are Rising Even More Than Its Stock

    February 22, 2024 at 4:21 AM EST. Save. Nvidia Corp. 's blowout earnings report lifted shares and assured the market that artificial intelligence mania is still going strong. It might also make ...

  23. Economic bubble Essays

    Economic bubble Essays. The Importance Of An Economic Bubble 708 Words | 3 Pages. INTRODUCTION - Bubbles An economic bubble is a phenomenon where market activity is heightened because of high expectations of returns, and optimism about potential returns due to technological advancement or discovery or due to anticipation of wealth creation ...

  24. 3 things could pop megacap stock bubble

    3 things could pop megacap stock bubble — and 'weigh heavily' on broader market Last Updated: Feb. 20, 2024 at 4:04 p.m. ET First Published: Feb. 20, 2024 at 12:33 p.m. ET

  25. Stock Rally Won't Last, AI Bubble Will Pop, Economy Will Sink: Jeremy

    The epic stock rally will end badly, the AI bubble will burst, and the economy will sink, warns elite investor Jeremy Grantham. Theron Mohamed. 2024-02-15T13:39:27Z

  26. The A.I. Economy Will Make Jobs More Human

    When Your Technical Skills Are Eclipsed, Your Humanity Will Matter More Than Ever. Feb. 14, 2024. Kate Dehler. 545. By Aneesh Raman and Maria Flynn. Mr. Raman is a work force expert at LinkedIn ...

  27. The Summary of Economic Bubbles

    Economic bubble is a term used to define the trade of products and assets at highly inflated prices that are considerably beyond the assets intrinsic value. Economic bubbles are formed as a result of speculation by the investors who feel very optimistic about the future increase… Download full paper File format: .doc, available for editing

  28. Jeremy Grantham on Stocks, Real Estate, AI Bubble, Fed, Economic Pain

    Jeremy Grantham issued warnings about stocks, real estate, and the economy this week. The elite investor predicted the AI bubble would pop, bringing down the stock market with it. Grantham slammed ...