Macroeconomic Dynamics



ARTICLES

DEFLATIONARY BUBBLES


WILLEM H. BUITER a1 and ANNE C. SIBERT a2c1
a1 London School of Economics and CEPR
a2 Birkbeck College, University of London and CEPR

Abstract

In an attempt to clean up an unruly literature, we specify the necessary and sufficient conditions for household optimality in a model where money is the only financial asset and provide the relevant proofs. We use our results to analyze when deflationary bubbles can and cannot exist. Our findings are in contrast to the results in several prominent contributions to the literature. We argue for particular specifications of the no-Ponzi-game restrictions on the representative household's and the government's intertemporal budget constraints in a model with money and bonds. Using the restriction on the household we derive the necessary and sufficient conditions for household optimality. The resulting equilibrium terminal conditions are then used to demonstrate that the existence of bonds does not affect when deflationary bubbles can and cannot occur. This result differs from that in other recent works.


Key Words: Transversality Conditions; No-Ponzi Game Condition; Deflationary Bubbles.

Correspondence:
c1 Address correspondence to: Anne C. Sibert, School of Economics, Mathematics and Statistics, Birkbeck College, Malet Street, London WCIE 7HX, United Kingdom; e-mail: asibert@econ.bbk.ac.uk.


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