Repeatedly bubbles occur during times of “extended investments in infrastructure such as canals or railroads”(Charles P. Kindleberger, “Manias, Panics and Crashes“, p. 10) or around technological inventions that are made available for the general public such as cars, electricity, phone – lines and the internet. They go hand in hand with financial inventions, financial liberalization and excess leverage. Examples are, among many others, the Japanese Asset Price bubble of the late 1980ies and early 1990ies, the Dot-Com bubble 1997–2000, as well as the recent Financial Crisis 2007-2008. Frequently these bubbles are fueled by the overoptimistic outlook not only of the so-called experts or gurus but also by the extremely positive perception of the general public resulting in a “this – time – is - different – feeling”, “new – era – talks” or the “it –won’t happen – to – us – believe”(See for example Shiller, Kindleberger, Reinhart and Rogoff, Galbraith). Most of the time these bubbles are self – feeding processes. Business expansion leads to economic growth and greater income. Public spending increases which leads to the need of expanding production. Credit is needed for investment and during times of a boom it is easily made available. Often new financial instruments come into play as well as the deregulation of financial markets to meet the demand for credit. Businesses can expand further which results in ever increasing income and greater expectations about the future. Creditors become less risk averse and grant loans to individuals or firms that would have not met the necessary requirements before. People feel richer since their wealth is re – classified so that their assets and property are all of the sudden worth more for no realistic reason (renovate a home for example which would account for an increase in value). In combination with low interest rates, more and more investments and purchases are financed through excess leverage creating a vicious cycle of easy credit, money illusion and the adjustment of fundamental values. Great hikes in the markets are considered as a result of the new economy that has been created. Historical levels of the markets and where the level of fundamentals should really be are completely ignored. Currently we can only assess bubbles in retrospective, psychological factors which may help to explain the unexplainable are hardly considered in basic economic models.The only thing that is certain is that bubbles always burst.
Table of Contents
1 Introduction
2 The course of a typical speculative episode
2.1 Japan and the Lost Decade
2.2 Irrational exuberance in the US
3 Common theory and quantifiable facts
3.1 Efficient market hypothesis
3.2 Eqilibria, bifurcations and chaos theory
3.3 Agent based financial market models
4 Structural factors triggering, amplifying and pricking economic bubbles – a reality check
4.1 Bubble catalyst - displacements
4.2 Magnifying mechanisms
4.2.1 Financial liberalization, the growth of credit, the quality of debt, supportive monetary and fiscal policy
4.2.2 Feedback loops, contagion and the role of the media
4.2.3 Rating Agencies
4.3 The big bang the other way around – the slowdown
5 Psychological factors triggering, amplifying and pricking economic bubbles – a reality check
5.1 Animal Spirits
5.1.1 Confidence
5.1.2 Fairness
5.1.3 Corruption
5.1.4 Money illusion
5.1.5 Stories
5.2 Bubble catalyst – psychological anchors for the markets that may trigger speculation
5.2.1 Quantitative anchors
5.2.2 Moral anchors
5.3 Magnifying mechanisms
5.3.1 Public attention to the markets and herding
5.3.2 New-era talk and short financial memory
5.3.3 Cultural changes
5.4 The big bang the other way around
6 Policy implications
6.1 Policy implications of a central bank
6.1.1 The “targeting long-run fundamentals” and “leaning against the wind” strategy
6.1.2 Reduced interest rates and the credit target
6.1.3 Other possible central bank measures
6.2 Policy implications of a government
6.2.1 The Tobin tax
6.2.2 Saving plans and retirement
6.2.3 Bretton Woods
6.3 Lender of last resort
7 Conclusion
Objectives & Core Themes
This master thesis aims to analyze the cyclical nature of economic bubbles, focusing on the structural and psychological determinants that trigger, amplify, and ultimately cause the collapse of speculative markets, such as the Japanese asset price bubble, the dot-com bubble, and the US housing crisis.
- The role of "animal spirits" and behavioral factors in market dynamics.
- Structural causes of bubbles, including financial liberalization and credit expansion.
- Feedback loops and the amplification of market speculation through media and social interaction.
- Evaluation of policy responses, including monetary, fiscal, and regulatory interventions.
Excerpt from the book
4.1 Bubble catalyst - displacements
Kindleberger and Aliber (2005) state that according to Hyman Minsky any crisis will start after displacements occur. “A displacement is an outside event or shock that changes horizons, expectations, anticipated profit opportunities [and] behavior…” either negatively or positively. Any shock must be large enough to have an impact on the system. A reoccurring displacement in the past was for example war. Seven to ten years after the end of such a war the series of crisis also seemed to be a reoccurring pattern. Kindleberger and Aliber (2005) assume that the time passed must have been long enough to adjust formerly overoptimistic expectations to realistic levels.
Any far reaching political, social and cultural changes like the ownership society under the Bush administration or the shift from governmentally supervised pension plans toward privatized pension plans are considered exogenous shocks, same accounts for monetary debasements and recoinages, which are regarded as displacements. As recent major displacements the authors list the deregulation of financial institutions and the advancement of financial innovations like mutual funds or credit default swaps (CDS) among others. The IT revolution of the 1990s is also considered as a major displacement.
Summary of Chapters
1 Introduction: Provides an overview of the recurring nature of economic bubbles, citing historical examples and the necessity of considering psychological factors.
2 The course of a typical speculative episode: Examines specific historical speculative periods, namely the Japanese "Lost Decade" and the US dot-com and housing bubbles.
3 Common theory and quantifiable facts: Evaluates traditional theoretical frameworks such as the Efficient Market Hypothesis against the reality of market volatility and chaos theory.
4 Structural factors triggering, amplifying and pricking economic bubbles – a reality check: Analyzes the structural determinants of bubbles, including credit growth, feedback loops, and the influence of rating agencies.
5 Psychological factors triggering, amplifying and pricking economic bubbles – a reality check: Investigates the behavioral and cognitive influences on markets, such as animal spirits, money illusion, and storytelling.
6 Policy implications: Discusses potential countermeasures for central banks and governments, including the Tobin tax, interest rate management, and deposit insurance.
7 Conclusion: Synthesizes findings on the interplay of structural and psychological factors, advocating for more robust, interdisciplinary models for financial market prediction.
Keywords
Economic Bubbles, Speculation, Financial Crisis, Animal Spirits, Market Psychology, Credit Expansion, Feedback Loops, Efficient Market Hypothesis, Rating Agencies, Tobin Tax, Behavioral Economics, Monetary Policy, Asset Prices, Contagion, Irrational Exuberance.
Frequently Asked Questions
What is the primary focus of this master thesis?
The work investigates the emergence, expansion, and implosion of recent economic bubbles, specifically examining the structural and psychological drivers behind market extremes.
What are the central thematic areas covered in the research?
The thesis covers market theory, structural triggers like credit expansion, behavioral aspects such as animal spirits and confidence, and policy measures aimed at market stabilization.
What is the main research question or objective?
The core objective is to identify the common circumstances and components—particularly psychological factors—that repeatedly cause financial markets to slide toward extremes.
Which scientific methods are employed?
The paper uses an analytical and qualitative approach, evaluating theoretical market models against historical data and existing literature on financial crises and behavioral economics.
What topics are discussed in the main body?
The main body explores the course of speculative episodes, critiques the Efficient Market Hypothesis, details the role of structural and psychological factors, and analyzes policy implications.
Which keywords best characterize the work?
Key terms include economic bubbles, animal spirits, market psychology, financial liberalization, feedback loops, and policy intervention.
How does the thesis explain the role of rating agencies in bubbles?
The work argues that rating agencies often fail to mitigate risk and can intensify bubbles due to conflicts of interest, moral hazard, and a reliance on relative rather than absolute valuation.
What role do "stories" play in the market according to the author?
The author emphasizes that stories are fundamental to human knowledge and confidence, acting as catalysts that spread contagion and rationalize speculative behavior during market booms.
- Quote paper
- Sophia Kuehnlenz (Author), 2013, Recent Economic Bubbles and Possible Implications for Economic Policy, Munich, GRIN Verlag, https://www.grin.com/document/264862
