Beautiful Cycles: A Theory and a Model Implying a Curious Role for Interest

Author/Editor:

Marco Gross

Publication Date:

March 5, 2021

Electronic Access:

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Summary:

Where do economic cycles come from? This paper contemplates an utmost minimalistic model and underlying theory that rest on two assumptions for letting them emerge endogenously: (1) the presence of interest-bearing debt; and (2) a degree of downward nominal wage rigidity. Despite its parsimony, the model generates well-behaved, self-evolving limit cycles and replicates six essential empirical facts: (1) booms are long- while recessions short-lived; (2) leverage is procyclical; (3) firm profit and wage shares in GDP are counter- and procyclical, respectively; (4) Phillips curves are downward-sloping and convex, and Okun’s law relation is replicated; (5) default cascades arise endogenously at the turning points to recessions; (6) lending spreads are countercyclical. One can refer to the model as being of a Dynamic Stochastic General Disequilibrium (DSGD) kind.

Series:

Working Paper No. 2021/067

Subject:

Frequency:

regular

English

Publication Date:

March 5, 2021

ISBN/ISSN:

9781513571676/1018-5941

Stock No:

WPIEA2021067

Format:

Paper

Pages:

37

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