Impact of an Economic Bubble

Robenson T

1. Introduction/Background

This research paper consists of varying viewpoints of the overall impact of economic bubbles. An economic bubble has been defined as a period of time in an economy, where prices strongly vary from the average normal daily prices. While researching the topic of economic bubbles and their specific effects on the Global economy, I found multiple different viewpoints and information. Some economists believe that economic bubbles are not the best for the economy, but do share some positive effects that contribute to the amount of spending consumers partake in. On the Other hand, some believe that due to the strong unpredictability economic bubbles contain, they have a very negative role on the economy. They believe this because giving the economy for unpredictability makes it increasingly challenging to improve the economy in the future. With so many economic problems that occur every day, it is important to be constantly thinking about how economic leaders can improve the economy.

2. Against the Economic Bubble

The stability of the Global economy has been fluctuating for many years. It seems, though, that every time an economist attempts to predict the economy, it follows another path which makes the economy seem as though it has a mind of its own. With so many different influential factors that contribute to the stability of the economy around the world, it is difficult to ever be certain what the economy will do in the future. An economic bubble is one of these factors that contribute to the stability of an economy. An economic bubble is a dramatic and random change in prices throughout the market that cause others to assume that the economy is strongly heading in a specific direction. Economic bubbles are known to create this illusion, because they are known to drastically “pop” and cause greater setbacks in the present economy. When such a dramatic and random change occurs, it is hard for economists to predict the outcome of this change. In the field of public administration plays a large role in connecting the needs of the community with the government. The economy affects this aspect of public administration tremendously. For example, many jobs in this industry deal with helping organizations meet the needs of the community. If a natural disaster were to occur in a city workers in public administration would attempt to assist relief organizations as much as possible to help those affected. It would also be the job of those in public administration to go then communicate to the government when more resources were needed to assist citizens. If the economy is struggling, it is increasingly more difficult for those in public administration to get the resources they need. Economic bubbles cause drastic instability in the economy, which will affect the availability of such resources to workers of public administration. It is obviously important to the government, to attempt to keep the economy as stable as possible, so that when the country is in need, they are there to provide needed support. Some economists argue that the economic bubble creates a positive increase in the over spending of consumers for a short period of time, while others argue that an economic bubble creates such an increased sense of unpredictability within the economy, that the economic bubble only causes drastic negative effects on the economy.

With many new and educated economists emerging around the world every year, there always are multiple and opposing viewpoints on the global economy. The Journal of Prediction Markets (2007) written by Georgios Tziralis and Ilias Tatsiopoulos reviews much of the literature published about Prediction Markets. Tziralis and Tatsiopoulos (2007) state, “The scheme used represents the authors’ view of the focus and direction of PM (potential market) research and reveals a rapid growth in the number of published articles” (p.1) This quote represents the popularity of predicting and writing about the prediction of markets. With many countries longing for their own personal economies to stabilize, many outcomes have occurred in result of each countries attempt in improving their own economic stability. A recent online article published from the popular website “The Guardian” and written by Ha-Joon Chang, talks about recent non-stabilizing trends in the global economy.

Chang’s (2014) article findings consisted of the following: According to the stock market, the UK economy is in a boom. Not just any old boom, but a historic one. On 28 October 2013, the FTSE 100 index hit 6,734, breaching the level achieved at the height of the economic boom before the 2008 global financial crisis (p.1).

This quote shows how economies around the world are experiencing the world of economic bubbles. This article explains how the UK has recently experienced this positive economic bubble that has caused some positive improvements on their economy. Chang (2014) explains, “Since then, it has had ups and downs, but on 21 February 2014 the FTSE 100 climbed to a new height of 6,838. At this rate, it may soon surpass the highest ever level reached since the index began in 1984” (p.1). This shows how while the UK was experiencing an economic bubble drastic economic improvements were shown within the country. Some can argue here, that an economic bubble is capable of producing some positive effects on a countries economy, but in this same article written be Ha-Joon Chang, it explains how these effects aren’t necessarily all that effective, due to their long lasting effects.

When an event or trend in the economy creates a short-term positive effect, it could potentially be viewed overall as negative due to the effect that this event or trend may cause more impactful and long-term negative effects. Chang (2014) gives an example of a negative effect still occurring during this period of by saying, “The UK economy has not yet recovered the ground lost since the 2008 crash; per capita income in the UK today is still lower than it was in 2007” (p. 1). This quote shows how economic struggles still exist when an economic bubble occurs within an economy. This quote shows that economic struggles are still present during an economic bubble, but does not prove that an economic bubble specifically causes problems within an economy.

There are many examples of economic bubbles in economies of countries around the world. With the U.S. recently experiencing seemingly constant financial instability, it is a perfect location to show examples of how economic bubbles affect an economy. Chang (2014) states that: The situation is even more worrying in the US. In March 2013, the standard & poor 500 stock market index reached the highest ever level, surpassing the 2007 peak (which was higher than the peak during the dotcom boom), despite the fact that the country’s per capita income had not yet recovered to its 2007 level. Since then, the index has risen about 20%, although the US per capita income has not increased even by 2% during the same period. This is definitely the biggest stock market bubble in modern history. (p. 2)

This quote expresses how the economic bubble was causing an overall economic struggle in the U.S. by allowing the very low per capita income to basically remain the same throughout this specific time period. This is expressed as the biggest stock market bubble in modern history most likely due to its drastic and rapid change in numbers that were unable to bounce back after the aftermath and financial toll this bubble had on the U.S. The U.S. government has been attempting to recover from this shot in the economy since it occurred in 2007. Many policies and economic reform plans have been discussed. Bubbles cause drastic misconceptions, which later make it difficult to formulate solutions to the problems these bubbles have caused. Later in the article a misconception in the U.S. economy was discussed. Chang (2014) describes this misconception, “During the dotcom bubble, the predominant view was that the new information technology was about to completely revolutionize our economies for good. Given this, it was argued, stock markets would keep rising (possibly forever) and reach unprecedented levels” (p.2). This is the perfect example of a rapid positive impact in the economy that was perceived to continue to grow positively in the future. Chang (2014) explains how this caused problems by saying, “Similarly, in the run-up to the 2008 crisis, inflated asset prices were justified in terms of the supposed progress in financial innovation and in the techniques of economic policy” (p.2) Increasing prices in hopes of increasing product was a mistake made due to the misleading positive impact the dotcom bubble produced. When economists make decisions based on the façade that economic bubbles create, it will just lead to more economic distress. This is now a known fact among U.S. economists that the current levels of share prices are unsustainable. For example Chang (2014) explains, “It is said that George Soros has already started betting against the US stock market” (p.2). In the introduction to the journal titled “The US Stock Market Leads the Federal Funds Rate and Treasury Bond Yields” written by Kun Guo, it makes a statement very similar to that of Chang’s. Guo (2011) explains, “The common wisdom asserts that the stock market variations and bond yield changes should be anti-correlated and the change in short-term interest rates, as a proxy of the monetary policy of the central bank, should be a predictor of the future stock market direction” (p.1). Many mistakes have allowed lessons been learned by economists from their reactions they have given towards these economic bubbles. Chang (2014) finalizes by saying, “The result, unfortunately, is that stock market bubbles of historic proportion are developing in the US and the UK, the two most important stock markets in the world, threatening to create yet another financial crash” (p.3). This quote directly correlates economic bubbles with an economic crash. This proves how much economic crashes stem from unstableness.

3. In Support of the Economic Bubble

Fluctuating viewpoints on the topic of economic bubbles strengthen each side of this opposing argument. The New York Times posted an article titled “The Mystery of Lofty Stock Market Elevations” written by Robert J. Shiller, that talks about the effects of a never ending fluctuating economy. This article talks about ratios and calculations that Robert J. Shiller has computed himself in order to better evaluate the economy. His article is based mostly off the data he has observed by computing what he calls The CAPE (cyclically adjusted price-earnings) ratio. Shiller (2014) explains his ratio, “It works like this: Using inflation-adjusted figures we divide stock prices by corporate earnings averaged over the preceding 10 years” (p.1). Using this ratio that he and his colleague John Y. Campbell created, allows him to back up his observations about the economy with data that he himself computed. In his article, he explains how his CAPE ratio is currently highly above average. Shiller (2014) explains, “Major market drops follow these CAPE peaks” (p.1). With many negative outlooks on this topic, Shiller goes on to explain some positive but also worrisome aspects of economic bubbles. Shiller (2014) asks, “Are there legitimate factors behind high stock prices that might keep them elevated for decades more?” (p.2). This question states that currently the prices of stocks are high. Shiller is curious if there are legitimate factors behind economic bubbles that could keep stock prices remaining high. With prices of stocks remaining high, this would keep stocks valuing at a higher value, which would create a positive impact on the economy. This could potentially increase spending because it could cause the “wealth effect” where consumers feel richer than they are in reality. Wikipedia (2014) explains, “When the bubble inevitably bursts, those who hold on to these overvalued assets usually experience a feeling of reduced wealth and tend to cut discretionary spending at the same time, hindering economic growth or, worse, exacerbating the economic slowdown” (p.3). Causing consumers the increased feeling of wealth would increase spending, which could potentially overall improve the economy of the U.

4. An Assessment of the Arguments

Both sides of this argument contain strengths and weaknesses that could potentially persuade readers to take a side. When an author is arguing a point that they believe, it is important to discuss the opposing side of the argument in order to make their argument more credible. This shows that the author understands the other side of the argument and is not writing his or her beliefs based on bias. This allows an author to gain credibility. Researching the topic of the overall effects of an economic bubble, many authors who chose to write about this topic, overall argued their points effectively. Chang mainly argued the negative outcomes of the fluctuation that economic bubbles cause. Chang gained credibility when he mentioned some financially positive happenings in the current UK economy, even though they are currently experiencing an economic bubble. This shows that Chang recognizes that economic bubbles do not fully cause economic destruction. Shiller gained much credibility in his argument by providing data and factual support to back up his economic observations and findings. He used real numbers in which he collected from a formula that was explained within the article. Shiller could have also used a formula from another source to gain even more credibility with his argument. Shiller provided a positive example of a positive impact economic bubbles may have, when he mentioned the fact that stock market prices are currently high. Asking questions throughout the article also allows the reader to formulate his or her own opinions which shows Shiller is trying to get the reader to be independent in their thoughts. This makes Shiller’s argument slightly less persuasive. The journals cited in this source provide excellent data and research to back up many points collected from online articles. Backing any opinion up with support always improves the quality of an argument overall. Overall there is a much stronger argument behind the observation that economic bubbles create more negative impacts and positive. This argument is stronger because it contains much factual evidence and examples behind it to make it credible and accurate.

5. Conclusion

An economy is constantly changing. It has become almost nearly impossible to predict the exact patterns the economy follows. With so many different factors contributing to the economy, it is amazing how much information exists on the economy today. With economic bubbles existing currently, it is important to take into consideration their past effects and results in economies around the world. Using the past as a template could assist economists in predicating what may happen to these economies in the future. It is important for countries not to get caught up in the initial wealthier feeling these economic bubbles may place upon them. The best way to deal with these bubbles is to focus on reviving the existing economy. Even though prices may be high, they may all be justified within a strong excelling economy. Higher prices may be justified as long as consumers consistently decide to spend. This will create a more sustainable increase in consumption which will benefit many aspects and area of the economy overall. It is important to look at not only our own country’s economy, but also the economy of surrounding countries whose economies directly affect us. The economy is a global topic that must work on all sides in order to function properly and successfully. Economic bubbles successfully have been observed to increase prices, which could lead to a stronger economy, but has been researched and proven to break economies apart. This can be prevented in the future if more research is put in place as to how these economic bubbles began and ended in the complicated economic past.

6. References

Chang, H. (2014, February 24). This is no recovery, this is a bubble- and it will burst. Retrieved October 1, 2014.

Guo, K., Zhou, W., Cheng, S., Sornette, D., & Rustichini, A. (2011). The US Stock Market Leads the Federal Funds Rate and Treasury Bond Yields.PLoS ONE,E22794-E22794.

Precise, T. (2014, August 10). Is it time for Wall Street to issue a correction? Retrieved October 1, 2014.

Shiller, R. (2014, August 16). The Mystery of Lofty Stock Market Elevations. Retrieved October 1, 2014.

Tziralis, G., & Tatsiopoulos, I. (2012). Prediction markets: An extended literature review.The journal of prediction markets,1(1), 75-91.