An endogenous mechanism of business cycles

Abstract

This paper suggests that business cycles may be a manifestation of coupled real economy and stock market dynamics and describes a mechanism that can generate economic fluctuations consistent with observed business cycles. To this end, we seek to incorporate into the macroeconomic framework a dynamic stock market model based on opinion interactions (Gusev et al., 2015). We derive this model from microfoundations, provide its empirical verification, demonstrate that it contains the efficient market as a particular regime and establish a link through which macroeconomic models can be attached for the study of real economy and stock market interaction. To examine key effects, we link it with a simple macroeconomic model (Blanchard, 1981). The coupled system generates nontrivial endogenous dynamics, which exhibit deterministic and stochastic features, producing quasiperiodic fluctuations (business cycles). We also inspect this system's behavior in the phase space. The real economy and the stock market coevolve dynamically along the path governed by a stochastically-forced dynamical system with two stable equilibria, one where the economy expands and the other where it contracts, resulting in business cycles identified as the coherence resonance phenomenon. Thus, the incorporation of stock market dynamics into the macroeconomic framework, as presented here, allows the derivation of realistic behaviors in a tractable setting.Note that the price drift is positive provided > * 2 ⁄ , which means that, in the long run, good news reflective of technological progress must (approximately) exceed expectations to sustain the longterm growth.Hence, as expected, model (11-13) does not refute the efficient market model but instead encompasses it as a particular case. To sum up, the results reported so far enable us to reasonably conclude that model (11)(12)(13), derived from first principles, establishes a general, tractable and credible 14 Blanchard (1981) also included a fiscal policy term. We do not consider policy effects in this work. 15 Equation (17) can be obtained, as a limiting case, from a dynamic extension of Cobb-Douglas production,where output adjusts over time to changes in capital subject to credit frictions (Gusev et al, 2019).

Capital Demand Driven Business Cycles: Mechanism and Effects

“…This drift imposes a slow timescale t ≥ O(τ y ) on the frequency of the economy's fluctuations by modulating the probability of regime transition. This effect was first observed and explained for a similar dynamical system inKroujiline et al (2019).…”

“…In the case where capital demand is persistently higher than supply, the model recovers the exponential equilibrium growth of the classic Solow model. In the opposite case, where capital demand is persistently lower than supply, the model exhibits quasiperiodic fluctuations driven by a coherence resonance mechanism similar to that in Kroujiline et al (2019).…”

“…On that point, we take note of Kroujiline et al (2019) which studies combined effects in a coupled macroeconomic system, attaching the interactions-based stock market model of Gusev et al (2015) (capable of producing relatively short-term endogenous cycles) to the simple phenomenological model of the economy of Blanchard (1981) (within which output follows slow relaxation dynamics) to obtain quasiperiodic fluctuations with the same frequency as observed business cycles. A natural next step would be to investigate whether a more advanced coupled system, where both the financial sector and the real economy experience nonlinear endogenous dynamics at different frequencies 21 can replicate and explain observed macroeconomic behaviors in greater detail.…”