May 25, 2024

What is an Economic Bubble?

In economic terms, a bubble is high volume levels of trading at extreme prices that do not align with true intrinsic values. In a simpler definition, it is the buying and selling of assets with inflated values.

The bubbles continue to grow until investors realize that asset prices are much higher than they should be; Then there is a sales wave and this situation ends with a decrease that may cause the asset prices to collapse in the market.

Bubbles may also be called a market bubble, speculative bubble, price bubble, or speculation frenzy, or, depending on the type, real estate bubble .

Is It Possible to Predict Balloons?

In the event of a bubble, asset prices can change wildly and very quickly. Moreover, these changes are often unpredictable and unpredictable.

Even if there is no speculation, uncertainty or limited rationality in the market, there are countless opinions about the reasons why bubbles occur. Many of these views are close to each other.

Mainstream economics demonstrates that bubbles cannot be predicted and stopped before or during their formation. Accordingly, the development of bubbles cannot be stopped because such a move would lead to financial crises. According to this view, authorities will need to deal with the consequences by using fiscal and monetary policy tools after the bubble bursts.

On the other hand, the Austrian school of economics argues that economic bubbles always have negative effects on economies. The main reason for this is that balloons lead to inefficient and wasteful use of economic resources.

Balloon Examples in History

When looking at the past of financial markets, it is possible to see examples of bubbles. Especially in the US economy, examples of economic bubbles abound.

For example, in the 1970s, when the US ended the implementation of the gold standard , American monetary expansion caused enormous bubbles in commodities. These bubbles finally ended after the US Federal Reserve raised interest rates above 14%. This caused the commodity bubble to burst, which caused gold and oil to fall to historically normal levels.

The rapid growth of the technology sector in the late 1990s and early 2000s is also one of the most obvious examples of a bubble. As more and more people started using the internet, investors paid much higher prices with high expectations for the stocks of dot-com companies that created a boom period. In the end, many of these companies failed to make a profit, and their shares quickly depreciated. Huge losses remained.

Another example of economic bubbles was the housing and stock market bubbles, which rose as a result of the Fed’s low interest rates from 2001 to 2004. Especially the rapid increase in housing prices created an expectation of profit and caused Americans from all walks of life to borrow and buy second and third properties. These bubbles burst when interest rates returned to more normal levels.

The consequences of this were severe. Its impact spread to the financial system and the entire economy in 2007 and 2008. World economies were also adversely affected by this situation. This example is important for us to see how balloons grow before they burst, and how dangerous and harmful they are when they finally burst.

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