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Working Paper
Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies
This paper studies rational bubbles in non-linear dynamic general equilibrium models of the macroeconomy. The term ‘rational bubble’ refers to multiple equilibria due to the absence of a transversality condition (TVC) for capital. The lack of TVC can be due to an OLG population structure. If a TVC is imposed, the macro models considered here have a unique solution. Bubbles reflect self-fulfilling fluctuations in agents’ expectations about future investment. In contrast to explosive rational bubbles in linearized models (Blanchard (1979)), the rational bubbles in non-linear models here ...
Report
Good news is bad news: leverage cycles and sudden stops
We show that a model with imperfectly forecastable changes in future productivity and an occasionally binding collateral constraint can match a set of stylized facts about ?sudden stop? events. ?Good? news about future productivity raises leverage during times of expansion, increasing the probability that the constraint binds, and a sudden stop occurs, in future periods. The economy exhibits a boom period in the run-up to the sudden stop, with output, consumption, and investment all above trend, consistent with the data. During the sudden stop, the nonlinear effects of the constraint induce ...
Working Paper
A Behavioral Foundation for the Investment Wedge
Motivated by behavioral evidence, we develop a tractable method for incorporating competition neglect in a general equilibrium firm investment problem. Competition neglect causes firms to systematically underestimate the investment of their competitors. When we introduce competition neglect into a canonical RBC model, this friction acts like an investment wedge that causes overinvestment at first, and underinvestment later on. In contrast to a model with exogenous investment shocks, these dynamics are accompanied by realistic variation in equity premia, even in the absence of financial ...