Technology shocks and predictable Minsky cycles

Abstract Big technological improvements in a new, secondary sector lead to a period of excitement about the future prospects of the overall economy, generating boom-bust dynamics propagating through credit markets. Increased future capital prices relax collateral constraints today, leading to a boom before the realization of the shock. But reallocation of capital toward the secondary sector when the shock hits leads to a bust going forward. These cycles are perfectly foreseen in our model, making them markedly different from the typical narrative about unexpected financial shocks used to explain crises. Our dynamics obtain without a departure from rational expectations. In fact, these cycles echo Minsky’s original narrative for financial cycles, according to which “financial trauma occur as normal functioning events in a capitalistic economy.” (Minsky, 1980, p. 21).