Question

How do economists define a "bubble"? Provide an example of an asset market that you think could be the next bubble and explain why.

Answer 1

An asset bubble is when assets rise in price over a short period that is not supported by the value of the product. The criteria of a bubble is irrational exuberance, a phenomenon when everyone is buying up a particular asset. When investors flock to an asset class, such as real estate, its demand and price increases.

During a bubble, investors continue to bid-up the price of an asset beyond any real, sustainable value. Eventually, the bubble "bursts" when prices crash, demand falls, and the outcome is often reduced business and household spending and a potential decline in the economy. Understanding the causes of asset bubbles can keep you from contributing and falling victim to a future one:

Low-interest rates: They make it easy to borrow money cheaply, which boosts investment spending. However, investors cannot receive a good return on their investments at these rates, so they move their money into higher-yield, higher-risk asset classes, spiking asset prices.

Demand-pull inflation: This occurs when buyers' demand for an asset exceeds the available supply of that asset. As asset prices rise, everyone wants to get in on the profits.

Asset shortage: This is when investors think that there is not enough of a given asset to go around. Such shortages make asset bubbles more likely because the imbalance between supply and demand leads prices to appreciate beyond the asset's value.

TRENDS:

Despite market volatility following recovery from the global financial crisis, historically low interest rates, increased consumer spending and higher business profits, a shift from investment in real estate to stocks, and low inflation and savings rates have contributed to soaring stock prices since 2017. The Dow rose above 21,000 in mid-2017. While it declined in early, mid-, and again in late 2018 amid trade tensions between the U.S. and China, the market rallied each time. The Dow is over 28,900 as of January 2020. The surge has increased worry among economists of a potential stock market bubble that could be headed for a burst. The burst is expected to come either as a market correction amounting to a decline of around 20%, or a larger crash. But the upswings and downswings make it hard to predict which form it will take and when.

Students have been racking up debt over the last 15 years. The typical student took out a loan of between $20,000 and $24,999 in 2018 compared with only $17,172 in 2005. High debt has been accompanied by a high delinquency rate. In 2018, 10% of adults with a bachelor's degree were behind on payments; the rate was 37% for students with associate's degrees. Some economists fear the burst of this asset bubble above all because it could have devastating consequences for the next generation. Students with sizable outstanding debt and limited government support may have to delay marriage, growing a family, buying property, or switching to a different career.