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Agency costs and business cycles

Author

Listed:
  • Timothy S. Fuerst

    (Federal Reserve Bank of Cleveland, Cleveland, OH 44101, USA)

  • Charles T. Carlstrom

    (Federal Reserve Bank of Cleveland, Cleveland, OH 44101, USA)

Abstract

This paper develops a model with endogenous agency costs that is otherwise quite similar to the canonical real business cycle model. The traditional assumption in the literature is that these agency costs arise in the production of investment goods. In contrast, this paper assumes that these costs are all encompassing in the sense that they arise in the production of aggregate output. The paper explores both the importance of the investment vs. output assumption for business cycle dynamics, and the conditions under which these agency models can deliver amplification and/or persistence. The paper has two principal conclusions. First, in terms of amplification and propagation, the output model performs worse than does the investment model. This arises because a variable distortion in the investment market has more of an impact than a comparable distortion in the output market. Second, in this model with optimal consumption choice by entrepreneurs, there is a clear tension between amplification and persistence.

Suggested Citation

  • Timothy S. Fuerst & Charles T. Carlstrom, 1998. "Agency costs and business cycles," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 12(3), pages 583-597.
  • Handle: RePEc:spr:joecth:v:12:y:1998:i:3:p:583-597
    Note: Received: December 30, 1997; revised version: April 1, 1998
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    More about this item

    Keywords

    Business fluctuations · Cycles · financial markets and the macroeconomy.;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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