Aggregate Demand Externality and Self-Fulfilling Default Cycles / Jess Benhabib, Feng Dong, Pengfei Wang, Zhenyang Xu.

Format:

Book

Author/Creator:

Benhabib, Jess.

Contributor:

National Bureau of Economic Research.

Dong, Feng.

Wang, Pengfei.

Xu, Zhenyang.

Series:

Working Paper Series (National Bureau of Economic Research) no. w32291.

NBER working paper series no. w32291

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2024.

Summary:

We develop a model of self-fulfilling default cycles with demand externality a la Dixit- Stiglitz to explain the recurrent clustered defaults observed in the data. The literature reports that observable fundamental factors alone are insufficient to explain the cluster. A decline in aggregate output reduces the value of firms and increases their probability of default. As defaults take more firms out of production, aggregate output declines further, creating a positive feedback loop that generates multiple equilibria and self-fulfilling default cycles. Our global analysis using Bogdanov-Takens bifurcation reveals the existence of multiple or even infinite paths that satisfy all equilibrium conditions. Moreover, a family of periodic orbits can emerge in the perfect foresight equilibrium. Our model is consistent with the view that business cycles arise largely because the economy's internal forces tend to endogenously generate cyclical mechanisms (Beaudry et al., 2020).

Notes:

Print version record

March 2024.