Working Paper: CEPR ID: DP13444
Authors: Kenza Benhima
Abstract: Dispersed information can generate booms and busts in economic activity. Boom-bust dynamics appear when firms are initially over-optimistic about demand due to a noisy private news. Consequently, they overproduce, which generates a boom and depresses their markups. Because the news is private, firms cannot relate these low markups to aggregate optimism. As low markups can also signal low demand, this overturns their expectations, generating a bust. We emphasize a novel role for imperfect common knowledge: dispersed information makes firms ignorant about their competitors' actions, which makes them confuse high noise-driven supply with low fundamental demand.
Keywords: Imperfect Common Knowledge; Expectations; Recessions
JEL Codes: E32; D83; D52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| dispersed information (D89) | overoptimism (D84) |
| overoptimism (D84) | overproduction (E23) |
| overproduction (E23) | boom (E32) |
| boom (E32) | decrease in markups (D43) |
| decrease in markups (D43) | confusion about demand state (R22) |
| confusion about demand state (R22) | formation of pessimistic expectations (D84) |
| formation of pessimistic expectations (D84) | bust (Y60) |
| less frequent noise shocks (C58) | more severe booms and busts (E32) |