Bubbles and Total Factor Productivity By JIANJUN MIAO AND PENGFEI WANG

Historical evidence shows that asset price bubbles typically precede financial crisis and fi-nancial crisis are accompanied by the collapse of bubbles. In addition, the stock market booms and busts are typically associated with the credit market booms and busts. The recent US housing and stock markets bubbles and the subsequent Great Recession starting in the late 2007 pro-vide an example. The stock market booms in early 1990s and the subsequent Asian financial crisis in 1997 provide another example. There are also many other related episodes of financial crisis in emerging economies. Motived by these observations, Jianjun Miao and Pengfei Wang (2011a) propose a theory of credit-driven stock price bubbles. They show that a positive feed-back loop mechanism generates stock price bub-bles when firms borrow against the stock mar-ket value of their collateralized assets to finance investment. Miao and Wang (2011a) assume that firms face stochastic investment opportuni-ties and bubbles improve investment efficiency. They also study stochastic bubbles and policy implications. In the present paper, we apply the theory de-veloped by Miao and Wang (2011a) to an en-vironment in which firms face idiosyncratic pro-ductivity shocks and credit constraints. We show that both bubbleless and bubbly equilibria can exist. In the bubbly equilibrium, more produc-tive firms have higher stock price bubbles. These bubbles allow firms to relax credit constraints and improve investment efficiency and capital allocation. Consequently, capital is allocated more to more productive firms, leading to a rise in total factor productivity (TFP). On the other hand, the collapse of bubbles tightens the credi