A MODEL OF INTERACTION BETWEEN THE VIRTUAL AND THE REAL ECONOMY

This paper demonstrates through a formal model how the wealth effect created by a stock market boom leads to the expansion of demand and output mostly through debt-financed private consumption. However, inherent in this expansion is the threat of a subsequent contraction caused by the rising burden of servicing debt and falling creditworthiness. The formal analysis captures more precisely these conditions; it shows that, even in the medium run, the growth rates of the wealth in the stock market and of the real economy may move in opposite directions. Copyright © 2006 The Authors; Journal compilation © 2006 Blackwell Publishing Ltd.