Capital Demand Driven Business Cycles: Mechanism and Effects

TL;DR

This paper introduces a macroeconomic model based on capital demand that explains business cycle fluctuations through bi-stability and coherence resonance, linking micro-level investment decisions to macroeconomic dynamics.

Contribution

It develops a tractable macroeconomic model incorporating micro-level capital demand interactions, revealing endogenous bi-stability and quasiperiodic fluctuations in economic activity.

Findings

The model exhibits two stable equilibria: contraction and expansion.

Quasiperiodic fluctuations arise from coherence resonance between these states.

Stochastic limit cycles can produce fluctuations but lead to unrealistic growth dynamics.

Abstract

We develop a tractable macroeconomic model that captures dynamic behaviors across multiple timescales, including business cycles. The model is anchored in a dynamic capital demand framework reflecting an interactions-based process whereby firms determine capital needs and make investment decisions at the micro level. We derive equations for aggregate demand from this micro setting and embed them in the Solow growth economy. As a result, we obtain a closed-form dynamical system with which we study economic fluctuations and their impact on long-term growth. For realistic parameters, the model has two attracting equilibria: one at which the economy contracts and one at which it expands. This bi-stable configuration gives rise to quasiperiodic fluctuations, characterized by the economy's prolonged entrapment in either a contraction or expansion mode punctuated by rapid alternations between them. We identify the underlying endogenous mechanism as a coherence resonance phenomenon. In addition, the model admits a stochastic limit cycle likewise capable of generating quasiperiodic fluctuations; however, we show that these fluctuations cannot be realized as they induce unrealistic growth dynamics. We further find that while the fluctuations powered by coherence resonance can cause substantial excursions from the equilibrium growth path, such deviations vanish in the long run as supply and demand converge.