Financial Markets, the Real Economy, and Self-fulfilling Uncertainties / Jess Benhabib, Xuewen Liu, Pengfei Wang.

Format:

Book

Author/Creator:

Benhabib, Jess.

Contributor:

National Bureau of Economic Research.

Liu, Xuewen.

Wang, Pengfei.

Series:

Working Paper Series (National Bureau of Economic Research) no. w24984.

NBER working paper series no. w24984

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2018.

Summary:

Uncertainty in both financial markets and the real economy rises sharply during recessions. We develop a model of informational interdependence between financial markets and the real economy, linking uncertainty to information production and aggregate economic activities. We argue that there exists mutual learning between financial markets and the real economy. Their joint information productions determine both the allocative efficiency in the real sector and the market efficiency in the financial sector. The mutual learning creates a strategic complementarity between information production in the financial sector and that in the real sector. A self-fulfilling surge in financial uncertainty and real uncertainty can naturally arise when both sectors produce little information in anticipation of the other producing little information. At the same time, aggregate output falls as the real allocative efficiency deteriorates. In the extension to an OLG dynamic setting, our model characterizes self-fulfilling uncertainty traps with two steady-state equilibria and a two-stage economic crisis in transitional dynamics.

Notes:

Print version record

September 2018.