SMU SOE Seminar Series (March 12, 2026): Bubbly Cycles of Global Imbalances

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ABSTRACT

This paper develops a tractable two-country overlapping generation model with endogenous leverage ratios and asset bubbles. Low interest rates, resulting from excessive credit expansion, may limit firms' borrowing capacity due to the exacerbated moral hazard problem in the credit market. The global imbalances featured by the capital flowing from the South to the North can endogenously trigger a global financial crisis if financial frictions in the former are sufficiently pronounced. Asset bubbles can serve as a buffer, absorbing excess liquidity and delaying crisis onset. However, the burst of asset bubbles may still induce crises, leading to a more severe recession. Policy analysis shows that subsidies or bailouts for bubbles can mitigate the welfare losses associated with a bubble bursting and that government bonds can prevent a crisis by absorbing excessive credit supply without the risk of a bubble burst. Relevant empirical evidence supports the main results of the models.