Growth Cycles

By Paul EvansGeorge RomerSeppo Honkapohja
1996| Working Paper No. 1405

We construct a rational expectations model in which aggregrate growth alternates between a low growth and a high growth state. When all agents expect growth to be slow, the returns on investment are low and little investment take place. This slows growth and confirms the prediction that the returns on investment will be low. But if agents expect fast growth, investment is high, returns are high, and growth is rapid. This expectational indeterminacy is induced by complementarity between different types of capital goods. In a growth and agents take full account of these transitions. The rules that agents need to form rational expectations in this equilibrium are simple. The equilibrium with growth cycles is stable under the dynamics implied by a correspondingly simple learning rule.