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When Can Changes in Expectations Cause Business Cycle Fluctuations?

  • Franck Portier
  • Paul Beaudry

ABSTRACT Business cycle fluctuations are generally associated with positive co-movement between consumption, investment and employment. In this paper we examine when such positive co-movement can arise in market settings as the result of changes in expectations. We show that most of the standard neo-classical models used in the macro literature can not support such phenomena; but that such phenomena is possible in a perfect market setting if multi-product firms are present. The key characteristic which we isolate as giving rise to the possibility of expectation driven fluctuations is that intermediate good producers exhibit internal cost complementarity when supplying goods to different sectors of the economy. Our analysis thereby identifies technological conditions under which business cycles may arise as a purely demand driven phenomena, as in traditional Keynesian models, without the need to invoke any market imperfections such as sticky prices, imperfect competition, increasing returns to scale or externatilities. In this sense, our analysis offers a potentially robust explanation to why market economies may exhibit business cycle fluctuations driven by changes in expectations.

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 865.

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Date of creation: 2004
Date of revision:
Handle: RePEc:red:sed004:865
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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