A Nonlinear Model of the Business Cycle

There is now a great deal of empirical evidence that business cycle fluctuations contain asymmetries. I focus on a theoretical model intended to capture the nonlinear behavior of aggregate output following a large negative shock. Nonlinearity introduced by Bayesian updating and an information externality produces an economy in which the response to large negative shocks is an increase in future output. The expansionary effect is produced by the negative shock imparting information about what not to do.