Readers Question: In finance and economics, there are such things as “bubbles” in the economy. And when bubbles start forming, it normally isn’t a good thing. My question is, how many different kinds of “bubbles” are there? Such as the property bubble or stock market bubble. And how do they form and what are their economic impacts?

Bubbles typically refer to a situation where assets or financial instruments see a rapid increase in price – an increase in price which is driven by speculative demand and are unsustainable in the long run. At a certain price, the bubble ‘bursts’ and prices come down to a level which more closely reflects the fundamental economic value. A bubble strongly implies that psychological factors such as irrational exuberance and over-confidence play a role in increasing the value of the asset.

Different Types of Bubbles

• Market Bubble. When a particular market sees a rapid increase in price. For example, this could be a housing bubble.
• Commodity bubble. When the price of one commodity or several commodities increases in price. For example, we might see a speculative bubble in the price of gold, e.g. in the 1970s and 1980.
• Stock market bubble. When the value of stocks and shares increase rapidly, e.g. prices increase faster than earnings. A stock market bubble is vulnerable to a crash, where market traders come to feel the bubble prices are over-inflated.
• Credit bubbles. A rapid growth in consumer and business credit to finance higher consumer spending.
• Economic boom/bubble. Related to the concept of market bubbles is the idea of a general economic boom. A boom implies that the economy expands at an unsustainably fast rate, leading to inflation (e.g. aggregate demand grows faster than productive capacity). Ultimately an economic boom usually proves unsustainable. There may be a strong link between market bubbles and an economic boom. For example, a house price bubble may cause rising wealth and confidence leading to higher consumer spending and economic growth. In turn, the higher economic growth feeds the housing boom.

Examples of Bubbles

• South Sea Bubble 1711-1720  A company set up to profit from British trade with South America. The price of shares rose rapidly, but with the company failing to make any real profit, share prices collapsed in 1720 and returned to pre-issue levels.
• Tulip mania of the 1630s. When the price of tulips rose to over 500 times their previous price before collapsing when buyers stopped entering the market.
• 1920s credit and the housing bubble in U.S. In the 1920s, there was a rapid growth of credit in the US. This financed a boom in house building and also a boom in the stock market. This rise in credit and share prices came to an abrupt end in 1929 with prices crashing.
• Dot Com Bubble. A rapid growth in the share value of internet shares in 1997-2000.
• Credit bubble of 2000s, which saw a rise in asset prices and bank lending.

• Bitcoin bubble the latest bubble?
• Bond bubble? Some argue there is a bond bubble with bond prices over-inflated by quantitative easing. Others argue it isn’t a bubble but reflection of a liquidity trap.

House price bubble

Between 2000 and 2006, house prices rose 80% and house price to earning ratios rose above long-term averages. This was partly fuelled by a growth in mortgage lending to subprime customers. When interest rates rose a modest amount in 2004/05, the housing market started to turn and prices fell 2006-12.

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