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Title: Reviving the Limit Cycle View of Macroeconomic Fluctuations

Author(s): Paul Beaudry, Dana Galizia and Franck Portier

Publication Date: June 2015

Keyword(s): Business Cycle, Limit Cycle and Unemployment

Programme Area(s): International Macroeconomics and Labour Economics

Abstract: There is a long tradition in macroeconomics suggesting that market imperfections may explain why economies repeatedly go through periods of booms and busts, with booms sowing the seeds of the subsequent busts. This idea can be captured mathematically as a limit cycle. For several reasons, limit cycles play almost no role in current mainstream business cycle theory. In this paper we present both a general structure and a particular model with the aim of giving new life to this mostly dismissed view of fluctuations. We begin by showing why and when models with strategic complementarities---which are quite common in macroeconomics---give rise to unique equilibrium dynamics characterized by a limit cycle. We then develop and estimate a fully-specified dynamic general equilibrium model that embeds a demand complementarity to see whether the data favors a configuration supportive of a limit cycle. Booms and busts arise endogenously in our setting because agents want to concentrate their purchases of goods at times when purchases by others are high, since in such situations unemployment is low and therefore taking on debt is perceived as being less risky. A key feature of our approach is that we allow limit-cycle forces to compete with exogenous disturbances in explaining the data. Our estimation results indicate that US business cycle fluctuations in employment and output can be well explained by endogenous demand-driven cycles buffeted by technological disturbances that render those fluctuations irregular.

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Bibliographic Reference

Beaudry, P, Galizia, D and Portier, F. 2015. 'Reviving the Limit Cycle View of Macroeconomic Fluctuations'. London, Centre for Economic Policy Research. http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10645