Beautiful cycles: A theory and a model implying a curious role for interest

Where do economic cycles come from? This paper contemplates an utmost minimalistic model and an underlying theory that rest on two assumptions that let them emerge endogenously: (1) the presence of interest-bearing debt, and (2) a degree of downward nominal wage rigidity. Despite its parsimony, the model generates well-behaved, self-evolving limit cycles and replicates six essential empirical facts: (1) booms are long, while recessions short-lived; (2) leverage is procyclical; (3) firm profit and wage shares are countercyclical and procyclical, respectively; (4) Phillips curves are downward-sloping and convex, and Okun’s law is replicated; (5) default cascades arise at the turning points to recessions; (6) lending spreads are countercyclical. One can refer to the model as being of a dynamic stochastic general disequilibrium (DSGD) kind.