Research Discussion Papers, Bank of Finland
No 24/2015:
Rational exuberance booms and asymmetric business cycles
Gene Ambrocio ()
Abstract: I propose a theory of information production and learning
in credit markets in which the incentives to engage in activities that
reveal information about aggregate fundamentals vary over the business
cycle and may account for both the excessive optimism that fueled booms
preceding financial crises and the slow recoveries that followed. In my
theory, information about aggregate fundamentals is produced along two
dimensions. First, optimistic beliefs lead to a fall in private investment
in information reducing the quality of information available, an intensive
margin. This gives rise to episodes of rational exuberance where optimism
sustains booms even as fundamentals decline in the buildup to crises.
Second, the quantity of information is increasing in the level of economic
activity, an extensive margin. Thus, recoveries are slow since the low
levels of investment and output provide little information about
improvements in the state of the economy. Consistent with model
predictions, I find supporting evidence in terms of a U-shaped pattern in
macro-uncertainty measures over the business cycle. I also discuss the
implications on endogenous information production on cyclical
macro-prudential policy.
Keywords: business cycle asymmetry; macro-uncertainty; social learning; (follow links to similar papers)
JEL-Codes: D83; E32; E44; G01; G14; (follow links to similar papers)
52 pages, November 25, 2015
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