TITLE:
A Theory on Origin of Speculative Bubbles and Public Debt Accumulation
AUTHORS:
Masayuki Otaki
KEYWORDS:
Speculative Bubbles, Limited Liability, Moral Hazard, Public Debt, Intergenerational Ethic
JOURNAL NAME:
Theoretical Economics Letters,
Vol.6 No.5,
October
20,
2016
ABSTRACT: I define a speculative bubble as the phenomenon in
which zero expected return assets possess positive economic values. The limited
liability principle matters in such a case. Individual investors prefer higher
risk and higher return assets under limited liability, and they become
incautious about the downside risk. Accordingly, even the zero expected return
assets have a positive market value. However, we must note that some substantial amount of government subsidies
should be introduced into the market to penetrate the limited liability
principle. As circulating such assets implies the prevalence of economy-wide
zero-sum game, if we presume the limited liability principle, additional
provision of an official subsidy is unavoidable to finance the private positive
gains. This finding implies that the precariousness of whether a speculative
bubble emerges vitally depends on the fiscal discipline of a government.
Whenever investors foresee a government’s forbearing policy, they invest in
riskier zero-sum assets, and there emerges a more violent speculative bubble.
In such a case, a huge amount of public debt is accumulated as a result of the
government’s aids. I negate not only the Ricardian equivalence theorem under
non-altruistic individuals but also the Lerner’s assertion that alleges the
issuance of a public debt to be irrelevant to the future resource allocation.
Therefore, speculative bubbles genetically distort the intergenerational
resource allocation, and hence, intergenerational ethic on the macroeconomic policy
should be urgently established.