Stock market cycles and supply side dynamics: two worlds, one vision?

Paul De Grauwe and Eddie Gerba ()

No 1626, Working Papers from Banco de España

Abstract: This paper compares two state-of-the-art but very distinct methods used in macroeconomics: rational-expectations DSGE and bounded rationality behavioural models. Both models are extended to include financial frictions on the supply side. The result in both frameworks is that production, supply of credit and the front payment to capital producers depend heavily on stock market cycles. During phases of optimism, credit is abundant, access to production capital is easy, the cash-in-advance constraint is lax, risks are undervalued, and production booms. But with a reversal in market sentiment, the contraction in all these parameters is deep and sometimes asymmetric. This is all the more evident in the behavioural model, where economic agents’ cognitive limitations exacerbate the contraction. While both models capture the empirical regularities very well, the validation exercise is even more favourable to the behavioural model

Keywords: supply side; beliefs; financial frictions; model validations (search for similar items in EconPapers)
JEL-codes: B41 C63 C68 E22 E23 E37 (search for similar items in EconPapers)
Pages: 124 pages
Date: 2016-10
New Economics Papers: this item is included in nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Stock Market Cycles and Supply Side Dynamics: Two Worlds, One Vision? (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:1626

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