News shocks, expectation driven business cycles and financial market frictions
نویسندگان
چکیده
This paper explores the booms and busts induced by news shocks in a model economy with financial market frictions. Firms can accumulate capital through either purchase of the existing capital or producing new capital by themselves. Firms need to borrow from financial intermediaries to finance their purchases of capital. With the presence of financial market frictions, firms have to pay an external finance premium which depends inversely on their net values. This provides firms with an incentive to build up capital stocks now to lower the external finance premium in the future. When firms receive news indicating a future technology improvement, they anticipate the need for more capital and so more external finance in the future; they could lower their future external finance costs by building up their capital and net values now. By adding financial market frictions into an otherwise standard RBC model, this paper succeeds in generating a boom when a news shock hits the economy.
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