Endogenous business cycles in the Ramsey growth model

Abstract

The Ramsey model is an analytical structure aimed at explaining intertemporal optimal growth. As a consequence, business cycles cannot be generated resorting to this structure, unless one introduces some source of inefficiency. Our central argument is that firms forecast future demand using a simple rule and thus they fail to perceive the full extent in which demand is capable of growing. Hence, firms will not invest as much as it is economically feasible in each moment of time, and this mechanism leads eventually to business cycles. The paper contributes to the endogenous business cycles literature with an important new feature: we do not have to consider the labour market in order to generate fluctuations – the framework just assumes consumption and investment decisions.