FINANCIAL MARKET IMPERFECTIONS AND BUSINESS CYCLES

FINANCIAL MARKET IMPERFECTIONS AND BUSINESS CYCLES

February 1993 | BRUCE C. GREENWALD AND JOSEPH E. STIGLITZ
The paper by Bruce C. Greenwald and Joseph E. Stiglitz explores the impact of financial market imperfections, particularly those related to asymmetric information, on business cycles. These imperfections lead firms to act risk-averse, affecting their investment, production, and pricing decisions. The authors develop a macroeconomic model that accounts for various observed aspects of business cycles, including cyclical movements in real wages, output, and investment, as well as the sensitivity of the economy to small disturbances and persistence. The model highlights how firms, due to their limited ability to diversify risks, are more cautious in their economic decisions. This risk aversion is influenced by both the total net worth and liquid assets of firms, which can act as buffer stocks to absorb risks. The paper also discusses the role of bankruptcy costs in shaping firm behavior and aggregate supply, suggesting that the marginal bankruptcy risk increases with output levels. The authors derive a risk-based aggregate supply curve, which explains the persistence observed in macroeconomic time series and the characteristics of business fluctuations. They argue that changes in firms' perceptions of risks and their net worth position can significantly affect their willingness to produce, leading to shifts in supply curves that affect other firms and the overall economy. The paper emphasizes the importance of risk distribution and information imperfections in financial markets, integrating these concepts into macroeconomic traditions. It differs from previous work by focusing on the limitations of equity markets and the role of bankruptcy costs, rather than relying on costly state verification models. The model is constructed to illustrate the general properties of aggregate behavior in economies with risk-averse firms and limited access to equity. The authors conclude that the model provides a more satisfactory account of actual business cycles compared to wage-shock models, and it highlights the persistence and cyclical nature of economic fluctuations.The paper by Bruce C. Greenwald and Joseph E. Stiglitz explores the impact of financial market imperfections, particularly those related to asymmetric information, on business cycles. These imperfections lead firms to act risk-averse, affecting their investment, production, and pricing decisions. The authors develop a macroeconomic model that accounts for various observed aspects of business cycles, including cyclical movements in real wages, output, and investment, as well as the sensitivity of the economy to small disturbances and persistence. The model highlights how firms, due to their limited ability to diversify risks, are more cautious in their economic decisions. This risk aversion is influenced by both the total net worth and liquid assets of firms, which can act as buffer stocks to absorb risks. The paper also discusses the role of bankruptcy costs in shaping firm behavior and aggregate supply, suggesting that the marginal bankruptcy risk increases with output levels. The authors derive a risk-based aggregate supply curve, which explains the persistence observed in macroeconomic time series and the characteristics of business fluctuations. They argue that changes in firms' perceptions of risks and their net worth position can significantly affect their willingness to produce, leading to shifts in supply curves that affect other firms and the overall economy. The paper emphasizes the importance of risk distribution and information imperfections in financial markets, integrating these concepts into macroeconomic traditions. It differs from previous work by focusing on the limitations of equity markets and the role of bankruptcy costs, rather than relying on costly state verification models. The model is constructed to illustrate the general properties of aggregate behavior in economies with risk-averse firms and limited access to equity. The authors conclude that the model provides a more satisfactory account of actual business cycles compared to wage-shock models, and it highlights the persistence and cyclical nature of economic fluctuations.
Reach us at info@study.space