| Do business cycles represent optimal responses by rational agents to erratic changes in technology, or are they also influenced by factors that are unrelated to such fundamentals? After presenting a chapter that reviews real business cycle theory and the role of indeterminacy, I collect three essays in this dissertation that extend the analytical basis for understanding business cycles by considering the effect on system dynamics of self-fulfilling beliefs. The framework for this analysis is a general-equilibrium model that incorporates increasing returns to scale in the production technology. The model can possess indeterminate convergent paths to a unique steady state that allow variations in self-fulfilling beliefs or “sunspots” to become an independent source of shocks. I use preference specifications suggested by King, Plosser and Rebelo (1988) and restrict attention to those parameterizations suggested by empirical findings in returns to scale. The first essay examines whether indeterminacy helps to resolve the quantity anomaly in international business cycle models. The second essay studies the implications of indeterminacy for the shortrun dynamics of the trade balance and terms of trade. The third essay presents a two-sector business cycle model with dynamic capital utilization, and shows that indeterminacy arises in this environment with empirically supported levels of increasing returns to scale. |
