Expectation driven business cycles with limited enforcement

- Empirically news shocks yield positive response of macro quantities and stock prices.
- Our model gets the stock price response right.
- First time achieved in real one-sector model with two input factors.
- The key mechanism is financial frictions in the form of limited enforcement.
- Generates additional effect from future productivity on today's investment.

We explore shocks to expected future productivity in a model with limited enforcement of financial contracts. A microfounded collateral constraint implies that good news about future productivity yield an increase in stock prices, available credit and a general economic expansion.