Delay and Cycles

Abstract

When the profitability of investment depends on the general level of economic activity, entrepreneurs have an incentive to delay investments during a recession. Endogenous delay thus prolongs the recovery from a recession and heightens the effect of the boom. This paper describes a dynamic model that exhibits both delay and cycles and develops methods for analysing the role of delay in propogating business cycles. A number of interesting characteristics of the cycle are revealed. First, the effect of delay is asymmetric: it lengthens the recovery but not the downturn. Second, delay can increase the amplitude and typically reduces the frequency of the cycle. Third, it can reduce the average level of activity, but it achieves this effect by prolonging the recession rather than by reducing the amplitude of the cycle. The welfare effects of delay are ambiguous, however.