Intangible Capital, Relative Asset Shortages and Bubbles

We analyze an OLG economy with financial frictions and accumulation of both physical and intangible capital. The key difference between these two types of capital is that intangible capital cannot be used as collateral for borrowing. As intangibles become more important relative to physical capital in production, interest rates decline, creating the conditions for the emergence of rational bubbles in equilibrium. The model predicts that the dynamics of capital accumulation in developed economies together with the low pledgeability of intangible capital induces an abundance of low-yield assets and a scarcity of high-yield ones. In our view, this is an important mechanism behind the long-lasting sequence of asset price bubbles observed in the last decades. Our paper stresses this relative imbalance and links it to purely technological factors. We also analyze the question of dynamic efficiency, demonstrating that, in the presence of financial frictions, neither the interest rate test nor the test proposed by Abel et al. (1989) are appropriate. Finally we show that, in general, rational bubbles are not Pareto improving in our framework