Expectations Driven Business Cycles Featuring Growth Asymmetries

Abstract:     
Recent evidence suggests that agents' expectations may have played a role in several cyclical episodes such as the U.S. "new economy" boom in the late 1990s and the real estate boom in Japan in the 1980s. These business cycles feature long and gradual boom and sharp bust phases. Existing expectations driven business cycle models cannot reproduce this kind of growth asymmetry. This paper uses a neoclassical vintage capital model and introduces learning about future investment-specific technological change to capture the growth asymmetry in expectations driven cycles. The precision of information varies endogenously with the cycle. Agents learn faster in booms than in recessions as in Van Nieuwerburgh and Veldkamp (2006) and consequently form forecasts about tomorrow's productivity of newly installed capital that vary in accuracy. Simulation results show that the model with learning displays longer and more gradual booms as well as sharper bust phases than a model which excludes learning. It replicates the skewness of output, employment and capital observed in the data.

Number of Pages in PDF File: 30

Keywords: Business cycles, expectations, news shocks, growth asymmetry, learning

JEL Classification: E2, E3, D83

working papers series