History is evidence of how complicated it is to maintain and analyze economic trends. Economics has always been a complicated and complex subject. It contains several trends like inflation, deflation, and others.
In fact, most of these topics are still a debatable issue for economists. But it is generally too essential to study the minor concepts of economics and its sectors to study the overall economical outcome at macro and micro stages. These factors are also responsible for checking and measuring the growth of a country in terms of GNP and GDP.
In this blog, we will learn what an economic bubble is, the role it plays, the advantages it has, the cause behind it, and some major examples from the past.
What is an Economic Bubble?
A bubble in an economic cycle is often referred to as an economic bubble. It is characterized by an economic escalation in the market value. This escalation is basically seen in the price of assets. In simpler words, the unexpected inflation in the market is defined as a bubble.
And, when this inflation is followed by a quick deflation in the market, that contradictory situation is referred to as a crash or bubble burst. During a bubble situation, the assets or trade price typically increase within a price range. It greatly exceeds the asset’s intrinsic value.
What is the cause of a Bubble in the Economy?
Economists often argue for the cause of bubbles. It is always a topic of dispute. Some economists say that the bubble is created in economics by a surge in asset prices. It is driven by excited market behavior.
While other economists don’t even believe about the existence of bubbles. Bubbles are usually identified and analyzed after the market faces a massive drop in prices.
How does an economic bubble work?
As mentioned above, an economic bubble occurs when the price of goods rises far above the real value. It is typically credited to a change in investor behavior. Though, the cause of this change and fluctuation is debatable among economists.
When a bubble phase occurs in an economy, the resources are transferred to the areas of rapid growth. This instantly led to inflation in the economy, while at the end phase, resources were moved again, causing prices to deflate, thus deflation in the market.
Also Read | Deflation vs Disinflation
What are the Two Types of Economic Bubbles?
Though, there exists several types of bubbles. But economists primarily classify economic bubbles into two types: Equity bubble and Debt bubble. Here is the basic introduction for both.
This bubble is caused by tangible investments in the market. The other cause is unsustainable desire to satisfy the legitimate market in high demand. The characteristics of an equity bubble are easy liquidity, tangible and real assets. For example, Tulip Mania.
Debt bubble is caused by intangible or credit-based investment. It has very little or no ability to satisfy the growing demand in a non-existent market. The outcome of a debt bubble is often debt deflation, as debt bubbles are not backed up by real assets. The characteristics are extra hopes for a profit return and security. For example, the US housing bubble.
What is the Impact of a Bubble in the Economy?
Though, a topic of greatest debate, in general economic bubbles are not considered beneficial. But yeah, again the outcome depends on their formation and bursting. The major impact of bubbles in economy are as follows:
It is not possible to identify a bubble in advance.
The bursting of a bubble sometimes results in a financial crisis in the market.
The authorities should wait for the bubbles to burst of their own accord.
The bubble has a great afterwards effect on monetary policy and fiscal policy.
A bubble crash is responsible for loss of a large amount of wealth.
Economic malaise is another effect of the bubble crash.
The bubble severely leads to debt deflation.
Also Read | Resource Allocation
Examples of an Economic Bubble
Though, bubbles don’t occur usually and easily. But the economic history of the globe has witnessed some major bubble phases. The extraordinary examples of economic bubbles are:
The earliest counted economic bubble is observed in the early 1600s. It is named as Tulip Mania. It occurred in Holland. The economic story revolves around tulip bulb trade. A person purchased some tulip bulbs for making profits and creating bubbles, but the commodity collapsed and resulted in a panic at the end.
The Japanese economy faced a bubble in the 1980s. The bank cause of this bubble is deregulation in the country's banks. The outcome of this bubble was that the prices of real estate and stock prices increased.
Later, the global economy faced another bubble in the 1990s. It is known as the dot-com boom or dot-com bubble. This caused excessive speculation in the e-companies.
A large market correction occurred as people bought stocks at high prices, assuming that they could sell it later at higher prices, but later their expectations were ruined.
In the late 2000s, another bubble broke in the United States. It is known as the US housing bubble. Somewhere, it is the cause of the dot-com bubble only. During this phase, the demand for house ownership grows.
This increase resulted in a decline of interest rates. Thus, anyone in the US can own a home. The ultimate change in the environment has resulted in money mortgage.
What are the phases involved in an Economic Bubble?
The phases of a typical economic bubble are explained by an American economist Hyman P. Minsky. Through his research the economist tries to study the cause of financial instability and stages of a credit cycle.
But this also helped the readers to understand the phases and patterns of an economic bubble. Following five phases are the parts of bubble:
Five Phases of an Economic Bubble
Displacement is the most initial stage of a bubble. The beginning phase when the investors start noticing a new paradigm in the market. This is basically done to grab their attention and can be anything like a product or technology.
Boom is the second phase of a bubble. It is the phase where prices start to rise. The market gets more momentum in this phase as more investors are attracted. And, thus it causes more people to buy assets.
Euphoria is the zenith stage of an economic bubble. When euphoria occurs when asset prices rise steeply. After this step, the investors are moved out of the frame.
The profit taking advantage is only for the persons who identify the early warning signs and make money only who can identify early warning signs that can make profits by selling off positions.
Panic is the final stage of an economic bubble. It is a decline in economics. It is the phase when the price of a commodity drops as rapidly as it has risen. When supply outshines the demand, the decline can be observed, and in such cases all the investors want is to liquidate the commodity at any price.
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Though, economic bubble is not very beneficial, it is an important trend in economics. It is responsible for instability in the economy, but instability is synonymous with economics. By deep analysis it can be possible to pre detect an economic bubble and simplify its effects. Later issues can be resolved by focusing on economic policies.