Question 4_Essay

Question 4_Essay - Question 4 An economic bubble occurs...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Question 4: An economic bubble occurs when an asset, commodity, or security trades in high volumes at prices that are at considerable variance from its “intrinsic value.” Because this intrinsic value is often difficult to price, often bubbles can only be identified retrospectively, when prices suddenly drop. This drop is known as a crash, or bubble burst. While speculation is the main driver of economic bubbles, the root causes of these bubbles are still up for debate, partly because the unique characteristics of individual actors, and possibly their hormones, make it difficult to explain macroeconomic trends. As a result, currently there is no widely accepted theory fully explaining the causes of economic bubbles. There are, however, some reputable theories on causes that are worth noting. First, some argue that excess monetary liquidity in the financial system directly contribute to the formation of bubbles. This excess liquidity occurs when central banks are engaged in expansionary monetary policy and lowering interest rates. When these interest rates go down, people have a greater incentive to leverage their capital and realize potentially higher returns by cheaply borrowing and less of an incentive to save or consume. As a result, there exists too much money in the economy with too few assets, causing all assets to appreciate to levels that reflect the amount of liquid, investment money in the economy. These price levels are higher than their true worth, and continue until the price becomes unsustainable or the money dries up. This theory is not perfect, however, as bubbles have appeared in strictly
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This essay was uploaded on 02/20/2009 for the course ILRIC 3330 taught by Professor Turner during the Spring '08 term at Cornell.

Page1 / 2

Question 4_Essay - Question 4 An economic bubble occurs...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online