An Expectations-Driven Interpretation of the “Great Recession”
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.
|Keywords||expectations-driven business cycles, intermediation shocks, news shocks, great recession, nancial accelerator.|
|JEL||Prices, Business Fluctuations, and Cycles (jel E3), Financial Markets and the Macroeconomy (jel E44)|
|Publisher||Department of Economics|
|Series||Carleton Economic Papers|
Gunn, C, & Johri, A. (2013). An Expectations-Driven Interpretation of the “Great Recession” (No. CEP 13-02). Carleton Economic Papers. Department of Economics.