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News and knowledge capital

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  • Christopher M. Gunn
  • Alok Johri

Abstract

We explore the ability of a model with knowledge capital to generate business cycles driven by expectations of future movement in total factor productivity (TFP). These cycles are characterized by a boom in which consumption, investment, output and hours-worked all rise in advance of any actual movement in TFP. We model knowledge capital as an input into production which is endogenously produced through a learning-by-doing process. When firms receive news of an impending productivity increase, the value of knowledge capital rises, inducing the firm to hire more hours to "invest" in knowledge capital. The rise in the value of knowledge capital immediately raises the value of the firm, causing an appreciation in share prices, a feature that has empirical support. The increase in output of the firm allows both consumption and investment to rise despite the absence of any contemporaneous productivity shock. If the expected increase in productivity fails to materialize, the model generates a recession as well as a crash in the stock market.

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Bibliographic Info

Paper provided by McMaster University in its series Department of Economics Working Papers with number 2009-02.

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Length: 40 pages
Date of creation: Feb 2009
Date of revision:
Handle: RePEc:mcm:deptwp:2009-02

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Keywords: Expectations-driven business cycle; Pigou cycle; News shock; Learning-by-doing; Asset pricing;

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