Stock Market Cycles and Supply Side Dynamics: Two Worlds, One Vision?

117 Pages Posted: 19 Nov 2015

See all articles by Paul De Grauwe

Paul De Grauwe

CESifo (Center for Economic Studies and Ifo Institute for Economic Research); London School of Economics & Political Science (LSE); Centre for Economic Policy Research (CEPR)

Eddie Gerba

Banco de España; London School of Economics & Political Science (LSE); CES Ifo Institute; European Central Bank

Multiple version iconThere are 3 versions of this paper

Date Written: October 27, 2015

Abstract

The paper compares two state-of-art but very distinct methods used in macroeconomics: rational-expectations DSGE and bounded rationality behavioural models. Both models are extended to include a financial friction on the supply side. The result in both models is that production, supply of credit and the front payment to capital producers depend heavily on the stock market cycles. During phases of optimism, credit is abundant, access to production capital is easy, the cash-in-advance constraint is lax, the risks are undervalued, and production is booming. But upon reversal in market sentiment, the contraction in all these parameters is deeper and asymmetric. This is even more evident in the behavioural model, where cognitive limitations of economic agents result in exacerbation of the contraction. While both models capture the empirical regularities very well, the validation exercise is even more favourable to the behavioural model.

Keywords: supply-side, beliefs, financial frictions, model validations

JEL Classification: B410, C630, C680, E220, E230, E370

Suggested Citation

De Grauwe, Paul and De Grauwe, Paul and Gerba, Eddie, Stock Market Cycles and Supply Side Dynamics: Two Worlds, One Vision? (October 27, 2015). CESifo Working Paper Series No. 5573, Available at SSRN: https://ssrn.com/abstract=2692985 or http://dx.doi.org/10.2139/ssrn.2692985

Paul De Grauwe

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Eddie Gerba (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain
(+34)917088132 (Phone)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

CES Ifo Institute ( email )

Poschinger Str. 5
Munich, 01069
Germany

European Central Bank ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
51
Abstract Views
601
Rank
312,805
PlumX Metrics