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News Shocks, Productivity and the U.S. Investment Boom-Bust Cycle

  • Lilia Karnizova


    (Department of Economics, University of Ottawa, Ottawa, ON)

Overly optimistic expectations concerning productivity and consequent downward revisions are commonly viewed as a key determinant of U.S. investment during the boom-bust cycle of 1995–2003. This view is formalized and evaluated in a general equilibrium model with news shocks about future productivity and preferences for financial wealth. The model generates a boom-bust cycle in response to good news that is not realized. A method is devised to estimate “the productivity prospects”: a series that captures the effects of news shocks on economic decisions. The estimated series rises during the boom, falls during the recession and helps forecast future productivity shocks at several horizons. The model's predictions for sample paths of hours worked, output, investment, consumption, wages and stock prices are largely in conformity with U.S. data. The model therefore offers a possible solution to several puzzles identified in the literature regarding the 1990's boom and the 2001 recession.

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Paper provided by University of Ottawa, Department of Economics in its series Working Papers with number 1201E.

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Length: 45 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:ott:wpaper:1201e
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