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DP5877 Can News About the Future Drive the Business Cycle?

Author(s): Nir Jaimovich , Sérgio Rebelo
Publication Date: October 2006
Keyword(s): business cycles , expectations , news
JEL(s): E3
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/pubs/dps/DP5877.asp


We propose a model that generates an economic expansion in response to good news about future total factor productivity (TFP) or investment-specific technical change. The model has three key elements: variable capital utilization, adjustment costs to investment, and preferences that exhibit a weak short-run wealth effect on the labour supply. These preferences nest the two classes of utility functions most widely used in the business cycle literature as special cases. Our model can generate recessions that resemble those of the post-war U.S. economy without relying on negative productivity shocks. The recessions are caused not by contemporaneous negative shocks but rather by lackluster news about future TFP or investment-specific technical change.

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