No. 229 Expectation Driven Business Cycles with Limited Enforcement
by Karl Walentin
April 2009 (updated August 2012)
We explore the implications of shocks to expected future productivity. In a setting with limited enforcement of financial contracts, firms have to post collateral to obtain external finance. In a real one-sector model with this type of "collateral constraint", positive news about future productivity implies an increase in stock prices and a relaxation of financing constraints that yield a general economic expansion, i.e. an expectation-driven business cycle. Furthermore, these properties are obtained with standard consumption preferences and capital adjustment costs.
business cycles, news shocks, limited enforcement, stock prices
E22, E32, E44, E51