This study estimates the response of macroeconomic variables to stock market fluctuations in Japan and the United States. It emphasizes the economy's reaction to stock market bubbles and crashes. To do this, I propose a new way to identify bubbles and crashes by testing price-to-fundamental ratios using the newly developed trend-filtering approach. Regardless of the measures used, both countries' macroeconomy tends to respond positively to the positive shock of stock price. Asymmetric effects of the stock market are observed. Japan's macroeconomic variables, especially investment and industrial production, are more sensitive to market crashes, while those of the United States are more sensitive to stock bubbles. Finally, I provide evidence that market sentiment can affect the economy either directly or indirectly through the stock market.

By considering a simple endogenous growth model, we propose a new theoretical channel through which the presence of asset bubbles can promote economic growth. In the model economy, long-lived value-maximizing firms continuously improve the quality of their specific products through in-house research and development (R&D), while simultaneously new firms enter into the market. The key feature is endogenous market structure: The number of firms is endogenously determined, which leads to variation in firm size measured in terms of the scale of production at the level of an individual firm. The presence of asset bubbles unambiguously gives rise to larger firms. This allows in-house R&D expenditure to be spread over the greater numbers of goods that the firms produce, which can increase incentives to undertake in-house R&D.

The financial crisis that started in August 2008 has reached a climax in the autumn of 2008 with a wave of bank nationalisations across North America and Europe. Although banking crises are not uncommon, this is the largest since 1929–33. This paper discusses the build-up to the crisis, looking at the role of low real interest rates in stimulating an asset price bubble. That bubble was stocked by financial innovation and increases in lending. New financial products were not stress tested and have failed in the downturn. After discussing the bubbles we look at the collapse of the complex asset structure, and then put the crisis in the context of the literature. The paper concludes with a discussion of policy implications of the crisis, and advocates a significant improvement in the regulatory structure.