Home > Economic Cycle, Growth, Inequality > A Bubble – what is it?

A Bubble – what is it?

bubble2Yale University economist and Nobel Laureate Robert Shiller describes a bubble as a “psycho-economic phenomenon. It’s like a mental illness. It is marked on excessive enthusiasm, participation of the news media and feelings of regret among people who weren’t in the bubble”

Others have suggested that bubbles are an increase in the price of an assets of no more than two standard deviations above the trend taking inflation into account. Bubbles have been a lot more prevalent since the 1960’s and this reflects the liberalising of financial markets and the end of the Bretton Woods system of fixed exchange rates in the 1970’s. Many economists have struggled to understand bubbles as in a rational and perfectly informed market assets that are overpriced should be sold. However the frenzy of the market can last much longer than investors think and the bursting of the bubble will be a gradual and slow process or a sudden drop in prices.

Housing bubbles tended to be supported by the banking industry.

* As most people take out a mortgage from a bank, rising house prices encourage banks to lend out more money as there is more security for them. However this greater availability of credit allows borrowers to afford higher prices.

* In contrast when the banks become reluctant to lend money and house prices can drop greatly. According to The Economist’s house price- indicators property in New Zealand (or should that be Auckland), Australia and Canada is overvalued. However could higher prices just reflect the level of income inequality that is clearly visible in most developed economies and conspicuous consumption. Thorstein Veblen wrote about this in his book The Theory of the Leisure Class (1899).

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