The boom-years preceding the "Great Recession" were a time of rapid innovation in the financial industry. We explore the idea that both the boom and eventual bust emerged from overoptimistic expectations of efficiency-gains in the financial sector. We treat the bankruptcy costs facing intermediaries in a costly state verification problem as a stochastic process, and model the boom-bust in terms of an unfulfilled news-shock where the expected fall in costs are eventually not realized. In response to a change in expectations only, the model generates a boom-bust cycle in aggregate activity, asset prices and leverage, and a countercyclical credit spread.

expectations-driven business cycles, intermediation shocks, news shocks, great recession, nancial accelerator.
Prices, Business Fluctuations, and Cycles (jel E3), Financial Markets and the Macroeconomy (jel E44)
Department of Economics
Carleton Economics Working Papers (CEWP)
Department of Economics

Gunn, C, & Johri, A. (2013). An Expectations-Driven Interpretation of the “Great Recession” (No. CEP 13-02). Carleton Economics Working Papers (CEWP). Department of Economics.