No. 229 Expectation Driven Business Cycles with Limited Enforcement

by Karl Walentin

April 2009 (updated August 2012)

Abstract

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.

Keywords

business cycles, news shocks, limited enforcement, stock prices

JEL codes

E22, E32, E44, E51