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.
|Journal||Journal of Monetary Economics|
Gunn, C, & Johri, A. (Alok). (2013). An expectations-driven interpretation of the "Great Recession". Journal of Monetary Economics, 60(4), 391–407. doi:10.1016/j.jmoneco.2013.04.003