DP13444 Booms and Busts with Dispersed Information

Author(s): Kenza Benhima
Publication Date: January 2019
Keyword(s): Expectations, Imperfect Common Knowledge, Recessions
JEL(s): D52, D83, E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13444

Dispersed information can generate booms and busts in economic activity. Boom-bust dynamics appear when firms are initially over-optimistic about demand due to a noisy private news. Consequently, they overproduce, which generates a boom and depresses their markups. Because the news is private, firms cannot relate these low markups to aggregate optimism. As low markups can also signal low demand, this overturns their expectations, generating a bust. We emphasize a novel role for imperfect common knowledge: dispersed information makes firms ignorant about their competitors' actions, which makes them confuse high noise-driven supply with low fundamental demand.