Strategic Information Manipulation as a Model of Assets and Aggregate Fluctuations

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Economy-wide fluctuations of employment investment and output can occur because of the way information flows in the economy, and the incentives individuals have to restrict those flows. This phenomenon is studied by bringing together mathematical building blocks developed separately in the investigator's earlier work. The first building block uses contract theory to show how information flows in asset markets. The second building block uses contract theory to show how feedback of information about economy-wide fluctuations of output flows to individuals. The novel element in this research is that a theory of assets is embedded in a rational expectations based model of aggregate fluctuations. This permits the investigator to study long standing questions about the relationship between asset behavior and business cycle fluctuations. Joining the two building blocks causes spillover effects in the form of economy-wide fluctuations-the business cycle-that cause asset markets to function less efficiently than they would in the absence of the fluctuations. Despite their adverse effect on asset markets, the fluctuations might nevertheless be desirable, and it might also be desirable that the fluctuations be long lasting, because they improve the flow of information.