B
Bubbles in History extended and gentler rise in prices, production,
and profits than a bubble and may be followed
Charles P. Kindleberger by crisis, sometimes taking the form of a crash
Organization Name, City, UK (or panic) or alternatively by a gentle subsidence
of the boom without crisis.
Bubbles have existed historically, at least in the
Keywords eyes of contemporary observers, as well as booms
Bank lending; Booms; Bubbles; German infla- so intense and excited that they have been called
tion (1923); Hedge finance; Kindleberger, ‘manias’. The most notable bubbles were the Mis-
C. P.; Law, J.; Mississippi bubble; Ponzi sissippi bubble in Paris in 1719–1720, set in
finance; Railway mania; Rational expecta- motion by John Law, founder of the Banque
tions; South Sea bubble; Speculative finance; Générale and the Banque Royale, and the contem-
Tulipmania poraneous and related South Sea bubble in
London. Most famous of the manias were the
Tulip mania in Holland in 1636 and the Railway
JEL Classifications mania in England in 1846–1847. It is sometimes
G1 debated whether a particular sharp rise and fall in
prices, such as the German hyperinflation from
Article 1920 to 1923, the rise and fall in commodity and
share prices in London and New York in
A bubble may be defined loosely as a sharp rise in 1919–1921, and the rise of gold of $850 an
price of an asset or a range of assets in a continu- ounce in 1982 and its subsequent fall to the $350
ous process, with the initial rise generating expec- level were or were not bubbles. Some theorists go
tations of further rises and attracting new buyers – further and question whether bubbles are possible
generally speculators interested in profits from with rational markets, which they assume exist
trading in the asset rather than its use or earning (see, e.g., Flood and Garber 1980).
capacity. The rise is usually followed by a reversal Rational expectations theory holds that prices
of expectations and a sharp decline in price often are formed within the limits of available informa-
resulting in financial crisis. A boom is a more tion by market participants using standard eco-
nomic models appropriate to the circumstances.
As such, it is claimed, market prices cannot
This chapter was originally published in The New Palgrave
Dictionary of Economics, 2nd edition, 2008. Edited by diverge from fundamental values unless the infor-
Steven N. Durlauf and Lawrence E. Blume mation proves to have been widely wrong. The
# The Author(s) 2008
Palgrave Macmillan (ed.), The New Palgrave Dictionary of Economics,
https://doi.org/10.1057/978-1-349-95121-5_3073-1
2 Bubbles in History
theoretical literature uses the assumption of the feedback, price increases greater than justified by
market having one mind and one purpose, market fundamentals, and booms of such dimen-
whereas it is observed historically that market sions as to threaten financial crisis, with possibil-
participants are often moved by different pur- ities of a crash or panic. Minsky (1982a, b) has
poses, operate with different wealth and informa- discussed how after an exogenous change in eco-
tion, and calculate within different time horizons. nomic circumstances has altered profit opportuni-
In early railway investment, for example, initial ties and expectations, bank lending can become
investors were persons doing business along the increasingly lax by rigorous standards. Critical
rights of way who sought benefits from the rail- exception has been taken to his taxonomy divid-
road for their other concerns. They were followed ing bank lending into hedge finance, to be repaid
by a second group of investors interested in the out of anticipated cash flows; speculative finance,
profits the railroad would earn, and by a third requiring later refinancing because the term of the
group, made up of speculators who, seeing the loan is less than the project’s payoff; and Ponzi
rise in the railroad’s shares, borrowed money or finance, in which the borrower expects to pay off
paid for the initial instalments with no intention of his loan with the proceeds of sale of an asset. It is
completing the purchase, to make a profit on objected especially that Carlo Ponzi was a swin-
resale. dler and that many loans of the third type, for
The objects of speculation resulting in bubbles example, those to finance construction, are
or booms and ending in numerous cases, but not entirely legitimate (Flemming et al. 1982). None-
all, in financial crisis, change from time to time theless, the suggestion that lending standards
and include commodities, domestic bonds, grow more lax during a boom and that the banking
domestic shares, foreign bonds, foreign shares, system on that account becomes more fragile has
urban and suburban real estate, rural land, leisure strong historical support. It is attested, and the
homes, shopping centres, Real Estate Investment contrary rational-expectations view of financial
Trusts, 747 aircraft, supertankers, so-called col- markets is falsified, by the experience of such a
lectibles such as paintings, jewellery, stamps, money and capital market as London having suc-
coins, antiques, etc. and, most recently, syndicated cessive booms, followed by crisis, the latter in
bank loans to developing countries. Within these 1810, 1819, 1825, 1836, 1847, 1857, 1866,
relatively broad categories, speculation may fix on 1890, 1900, and 1921 – a powerful record of
particular objects – insurance shares, South Amer- failing to learn from experience (Kindleberger
ican mining stocks, cotton-growing land, Paris 1978).
real estate, Post-Impressionist art, and the like.
At the time of writing, the theoretical literature
has yet to converge on an agreed definition of
See Also
bubbles and on whether they are possible. Virtu-
ally the same authors who could not reject the
▶ Tulipmania
no-bubbles hypothesis in the German inflation of
1923 one year, managed to do so a year later
(Flood and Garber 1980). Another pair of theo-
rists has demonstrated mathematically that ratio- Bibliography
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bubbles” on the grounds not of their non- Blanchard, O., and M.W. Watson. 1982. Bubbles, rational
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Short of bubbles, manias, and irrationality are Flemming, J.S., R.W. Goldsmith, and J. Melitz. 1982.
periods of euphoria which produce positive Comment. In Financial crises: Theory, history and
Bubbles in History 3
policy, ed. C.P. Kindleberger and J.-P. Laffargue. Cam- Minsky, H.P. 1982a. Can ‘it’ happen again?: Essays on
bridge: Cambridge University Press. instability and finance. Armonk: Sharpe.
Flood, R.P., and P.M. Garber. 1980. Market fundamentals Minsky, H.P. 1982b. The financial instability hypothesis.
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Political Economy 88: 745–770. P. Kindleberger and J.-P. Laffargue. Cambridge: Cam-
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A history of financial crises. New York: Basic Books.
