A Solow-Swan Growth Model with Bubbles and Intermediation

Abstract

In 1956, Robert Solow (1956) and Trevor Swan (1956) independently published work advocating changes in the existing growth models so capital and labor are not employed in fixed proportions. The Solow-Swan model shows allowing input substitution eliminates the "knife edge" problem present in the Harrod (1939) and Domar (1946) models. However, the Solow-Swan model has a different problem; it allows dynamic inefficiency in the form of capital over-accumulation. This thesis presents an extension of the Solow-Swan model allowing bubbly assets, in the form of loans to households, to be issued by a financial intermediary. It is shown that the economy will NOT tend to suffer from dynamic inefficiency if confidence can be maintained so that the intermediation sector can capture all of the potential gains that can be captured from the issuance of a bubbly asset.