Reviving the limit cycle view of macroeconomic fluctuations

By Paul Beaudry, Dana Galizia and Franck Portier

http://d.repec.org/n?u=RePEc:red:sed016:52&r=dge

There is a long tradition in macroeconomics suggesting that market imperfections may explain why economies repeatedly go through periods of booms and busts. This idea can be captured mathematically as a limit cycle. In this paper we present both a general structure and a particular model with the aim of giving new life to this mostly dismissed view of fluctuations. We begin by showing why and when models with strategic complementarities can give rise to unique-equilibrium dynamics characterized by a limit cycle. We then develop a fully-specified dynamic general equilibrium model that embeds a demand complementarity that allows for a limit cycle. Booms and busts arise endogenously in our setting because agents want to concentrate their purchases of goods at times when purchases by others are high, since in such situations unemployment is low and therefore taking on debt is perceived as being less risky. A key feature of our approach is that we allow limit-cycle forces to compete with exogenous disturbances in explaining the data. Our estimation results indicate that US business cycle fluctuations in employment and output can be well explained by endogenous demand-driven cycles buffeted by technological disturbances that render those fluctuations irregular.

This is going to be a controversial paper because it revisits theories that have been discredited, sometimes with choice words. Beaudry and Portier have successful in revisiting old theories or bringing distinct strands of literature together. We’ll whether this on does as well.

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