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An expectations-driven interpretation of the “Great Recession”

  • Gunn, Christopher M.
  • Johri, Alok

The boom-years preceding the “great recession” were a time of rapid innovation in the financial industry. We explore the idea that both the boom and eventual bust emerged from overoptimistic expectations of efficiency-gains in the financial sector. We treat the bankruptcy costs facing intermediaries in a costly state verification problem as a stochastic process, and model the boom-bust in terms of an unfulfilled news-shock where the expected fall in costs are eventually not realized. In response to a change in expectations only, the model generates a boom-bust cycle in aggregate activity, asset prices and leverage, and a countercyclical credit spread.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 60 (2013)
Issue (Month): 4 ()
Pages: 391-407

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Handle: RePEc:eee:moneco:v:60:y:2013:i:4:p:391-407
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  11. Christopher M. Gunn & Alok Johri, 2012. "News, Credit Spreads and Default Costs: An expectations-driven interpretation of the recent boom-bust cycle in the U.S," Department of Economics Working Papers 2012-04, McMaster University.
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  13. Christiano, Lawrence & Ilut, Cosmin & Motto, Roberto & Rostagno, Massimo, 2008. "Monetary policy and stock market boom-bust cycles," Working Paper Series 0955, European Central Bank.
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  17. Hashmat Khan & John Tsoukalas, 2009. "The Quantitative Importance of News Shocks in Estimated DSGE Models," Carleton Economic Papers 09-07, Carleton University, Department of Economics, revised 22 May 2012.
  18. Christopher M. Gunn & Alok Johri, 2011. "News, Intermediation Efficiency and Expectations-driven Boom-bust Cycles," Department of Economics Working Papers 2011-02, McMaster University.
  19. Gertler, Mark & Kiyotaki, Nobuhiro, 2010. "Financial Intermediation and Credit Policy in Business Cycle Analysis," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 11, pages 547-599 Elsevier.
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