Working Paper: NBER ID: w5659
Authors: George Evans; Seppo Honkapohja; Paul Romer
Abstract: We construct a rational expectations model in which aggregate growth alternates between a low growth and a high growth state. When all agents expect growth to be slow, the returns on investment are low, and little investment takes place. This slows growth and confirms the prediction that the returns on investment will be low. But if agents expect fast growth, investment is high, returns are high, and growth is rapid. This expectational indeterminacy is induced by complementarity between different types of capital goods. In a growth cycle there are stochastic shifts between high and low growth states and agents take full account of these transitions. The rules that agents need to form rational expectations in this equilibrium are simple. The equilibrium with growth cycles is stable under the dynamics implied by a correspondingly simple learning rule
Keywords: Expectations; Investment; Economic Growth; Rational Expectations
JEL Codes: E32; E37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expectations of slow growth (E66) | Reduced investment (G31) |
| Reduced investment (G31) | Confirmation of low growth expectations (E66) |
| Expectations of fast growth (O49) | Increased investment (E22) |
| Increased investment (E22) | Accelerated growth (O49) |
| Expectations (D84) | Investment decisions (G11) |
| Investment decisions (G11) | Economic growth (O00) |
| Complementarity between capital goods (E22) | Enhanced marginal productivity of capital (E22) |
| Expectational indeterminacy (D84) | Cyclical behavior in investment and growth (E32) |