Working Paper: CEPR ID: DP4628
Authors: Paul Beaudry; Franck Portier
Abstract: It is often argued that changes in expectation are an important driving force of the business cycle. It is well known, however, that changes in expectations cannot generate positive co-movement between consumption, investment and employment in the most standard neo-classical business cycle models. This gives rise to the question of whether changes in expectation can cause business cycle fluctuations in any neo-classical setting or whether such a phenomenon is inherently related to market imperfections. This Paper offers a systematic exploration of this issue. Our finding is that expectation driven business cycle fluctuations can arise in neo-classical models when one allows for a sufficiently rich description of the inter-sectorial production technology; however, such a structure is rarely allowed or explored in macro-models. In particular, the key characteristic which we isolate as giving rise to the possibility of expectation driven business cycles is that intermediate good producers exhibit cost complementarities (i.e., economies of scope) when supplying goods to different sectors of the economy.
Keywords: business cycles; expectations; multisectoral models
JEL Codes: E30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| changes in expectations (D84) | business cycle fluctuations (E32) |
| economies of scope (D26) | expectation-driven business cycles (E32) |
| cost complementarities (D10) | expectation-driven business cycles (E32) |
| expectation-driven business cycles (E32) | positive comovement between consumption, investment, and employment (E20) |
| traditional macroeconomic models (E19) | restrict production possibilities (D24) |
| internal cost complementarities (F12) | expectation-driven fluctuations (D84) |