Working Paper: NBER ID: w10776
Authors: Paul Beaudry; Franck Portier
Abstract: It is often argued that changes in expectation are an important driving force of the business cycle. However, it is well known 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 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 fluctuation can arise in neo-classical models when one allows for a sufficient rich description of the inter-sectorial production technology, however such a structure is rarely allowed 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 intermediate goods to different sectors of the economy.
Keywords: No keywords provided
JEL Codes: E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expectation-driven business cycles (E32) | positive comovement between consumption, investment, and employment (E20) |
| economies of scope (D26) | expectation-driven business cycles (E32) |
| production structure (L23) | expectation-driven business cycles (E32) |
| expectations (D84) | positive comovement between consumption, investment, and employment (E20) |
| restrictive production possibility set (D20) | preclusion of expectation-driven cycles (D84) |