Asset Bubbles, Unemployment, and a Financial Crisis

A tractable growth model with asset bubbles is presented to demonstrate that a financial crisis caused by a bubble bursting increases unemployment rates. A bubbly asset, which is intrinsically useless, has a positive market value because purchasing the asset is a sole saving method for agents who draw insufficiently low productivity, whereas selling the asset is a fund-raising method for agents who draw high productivity to initiate an investment project. The presence of asset bubbles corrects allocative inefficiency regarding production resources, relocating investment resources from low-productivity agents to high-productivity agents. Accordingly, the presence of asset bubbles can promote capital accumulation. As capital accumulates and output increases, the number of vacant positions increases because firms acquire more funds to cover a search cost. As a result, firms are incentivized to increase employment. However, extrinsic uncertainty may burst asset bubbles and cause a self-fulfilling financial crisis, which is followed by increased unemployment.