Asset Bubbles and Bailouts
41 Pages Posted: 8 May 2018
Date Written: September 25, 2015
As long as bubble size is relatively small, bubbles increase production level, but once the size becomes too large, then bubbles reduce it. Given this non-monotonic relationship, this paper investigates the relationship between bubbles and government bailouts. It shows that bailouts for bursting bubbles may positively influence ex-ante production efficiency and relax the existence condition of stochastic bubbles. The level of bailouts has a non-monotonic relationship with production efficiency and a "partial bailout" policy achieves production efficiency. Moreover, it examines the welfare effects of bailout policies rigorously and shows that even non-risky bubbles may be undesirable for taxpayers.
Keywords: Bubble Size, Anticipated Bailouts, Production Efficiency, Boom-Bust Cycles, Optimal Bailout Policy
JEL Classification: E32, E44, E61
Suggested Citation: Suggested Citation