An Endogenous Mechanism of Business Cycles

TL;DR

This paper introduces a coupled real economy and stock market model that generates endogenous business cycle fluctuations, linking microfoundations with macroeconomic dynamics and demonstrating realistic, quasiperiodic economic oscillations.

Contribution

It develops a microfounded stock market model integrated into macroeconomics, revealing endogenous business cycles through coupled dynamics and stochastic effects.

Findings

The coupled system produces quasiperiodic business cycles.

Stock market and real economy coevolve with two stable equilibria.

The model exhibits deterministic and stochastic features consistent with observed cycles.

Abstract

This paper suggests that business cycles may be a manifestation of coupled real economy and stock market dynamics and describes a mechanism that can generate economic fluctuations consistent with observed business cycles. To this end, we seek to incorporate into the macroeconomic framework a dynamic stock market model based on opinion interactions (Gusev et al., 2015). We derive this model from microfoundations, provide its empirical verification, demonstrate that it contains the efficient market as a particular regime and establish a link through which macroeconomic models can be attached for the study of real economy and stock market interaction. To examine key effects, we link it with a simple macroeconomic model (Blanchard, 1981). The coupled system generates nontrivial endogenous dynamics, which exhibit deterministic and stochastic features, producing quasiperiodic fluctuations (business cycles). We also inspect this system's behavior in the phase space. The real economy and the stock market coevolve dynamically along the path governed by a stochastically-forced dynamical system with two stable equilibria, one where the economy expands and the other where it contracts, resulting in business cycles identified as the coherence resonance phenomenon. Thus, the incorporation of stock market dynamics into the macroeconomic framework, as presented here, allows the derivation of realistic behaviors in a tractable setting.