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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.

Suggested Citation

  • Franck Portier & Paul Beaudry, 2004. "When Can Changes in Expectations Cause Business Cycle Fluctuations?," 2004 Meeting Papers 865, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:865

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    Cited by:

    1. Engel, Charles & Wang, Jian, 2011. "International trade in durable goods: Understanding volatility, cyclicality, and elasticities," Journal of International Economics, Elsevier, vol. 83(1), pages 37-52, January.
    2. Nir Jaimovich & Sergio Rebelo, 2009. "Can News about the Future Drive the Business Cycle?," American Economic Review, American Economic Association, vol. 99(4), pages 1097-1118, September.
    3. Pengfei Wang & Yi Wen, 2012. "Hayashi Meets Kiyotaki and Moore: A Theory of Capital Adjustment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(2), pages 207-225, April.
    4. Kobayashi Keiichiro & Nutahara Kengo, 2010. "Nominal Rigidities, News-Driven Business Cycles, and Monetary Policy," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-26, September.
    5. Nir Jaimovich & Sergio Rebelo, 2008. "News and Business Cycles in Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1699-1711, December.
    6. Koulovatianos, Christos & Mirman, Leonard J. & Santugini, Marc, 2009. "Optimal growth and uncertainty: Learning," Journal of Economic Theory, Elsevier, vol. 144(1), pages 280-295, January.
    7. Chen, Kaiji & Song, Zheng, 2013. "Financial frictions on capital allocation: A transmission mechanism of TFP fluctuations," Journal of Monetary Economics, Elsevier, vol. 60(6), pages 683-703.
    8. Fratzscher, Marcel & Straub, Roland, 2010. "Asset Prices, News Shocks and the Current Account," CEPR Discussion Papers 8080, C.E.P.R. Discussion Papers.
    9. R. Andrew Butters & Marcelo Veracierto, 2009. "Preannounced tax cuts and their potential influence on the 2001 recession," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q III, pages 44-60.
    10. Hammad Qureshi, 2009. "News Shocks and Learning-by-doing," Working Papers 09-06, Ohio State University, Department of Economics.
    11. Marcel Fratzscher & Roland Straub, 2009. "Asset Prices and Current Account Fluctuations in G-7 Economies," IMF Staff Papers, Palgrave Macmillan, vol. 56(3), pages 633-654, August.
    12. Keiichiro Kobayashi & Masaru Inaba, 2006. ""Irrational exuberance" in the Pigou cycle under collateral constraints," Discussion papers 06015, Research Institute of Economy, Trade and Industry (RIETI).
    13. Charlotta Groth & Hashmat Khan, 2007. "Investment adjustment costs: evidence from UK and US industries," Bank of England working papers 332, Bank of England.
    14. Brückner, Markus & Pappa, Evi, 2011. "For an Olive Wreath? Olympic Games and Anticipation Effects in Macroeconomics," CEPR Discussion Papers 8516, C.E.P.R. Discussion Papers.
    15. Engel, Charles & Wang, Jian, 2007. "International trade in durable goods: understanding volatility, cyclicality, and elastics," Globalization and Monetary Policy Institute Working Paper 03, Federal Reserve Bank of Dallas.
    16. Guido Lorenzoni, 2007. "News Shocks and Optimal Monetary Policy," NBER Working Papers 12898, National Bureau of Economic Research, Inc.
    17. Chen, Kaiji & Song, Zheng, 2007. "Financial Friction, Capital Reallocation and Expectation-Driven Business Cycles," MPRA Paper 3889, University Library of Munich, Germany.

    More about this item


    expectations; business cycles;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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