Technological Innovation and Bursting Bubbles

TL;DR

This paper develops a macro-finance model illustrating how technological innovation and knowledge spillovers influence stock bubbles and economic growth, showing bubbles can reinforce innovation and lead to sustained higher output despite inevitable bursts.

Contribution

It introduces a macro-finance framework linking innovation, knowledge spillovers, and stock bubbles, highlighting their mutual reinforcement and long-term economic effects.

Findings

Stock bubbles necessarily emerge in the model.

Bubbles and innovation mutually reinforce each other.

Technological advancements during bubbles lead to higher long-term output.

Abstract

We present a macro-finance model with innovation and knowledge spillover. Skilled agents engage in R&D activities (establish firms) or work in the knowledge-intensive sector. Unskilled agents work in the traditional sector. Knowledge spillover from innovations to the two sectors is initially high and uneven (unbalanced growth), but eventually weakens and equalizes (balanced growth). A rational stock bubble (prices exceed fundamentals) necessarily emerges, even though it is expected to burst with regime switching. Despite the inevitable collapse, stock bubbles and technological innovation reinforce each other and lead to permanently higher output and wages because technologies developed during the bubble era prevail.