Reviewing the sources of fluctuations in the US business cycle, the authors reassess the empirical evidence that favors a news-driven business cycle and find that news shocks are a quantitatively important source of fluctuations in the macroeconomic cycle. According to the news view of business cycles, booms arise mainly as a result of speculation. Another essential point is that although it is not possible to identify separately true news shocks and noise shocks, the news view—and empirical results—can be incorporated into the two benchmark models of modern macroeconomics: the RBC (real business cycle) model and the New Keynesian model.

The authors aim to identify the principal driving forces behind macroeconomic fluctuations. In the past several years, an older theory advanced by Pigou (Industrial Fluctuations 1927), which posits that business cycles can arise without any change in fundamentals, has been resuscitated. The news-driven business cycle hypothesis is that business cycles might arise on the basis of expectations of future fundamentals. This macroeconomic approach closely corresponds to Keynes’s 1936 notion of “animal spirits” as it relates to waves of optimism and pessimism as important driving forces behind economic fluctuations.

The approach offers an alternative perspective on recurrent boom and bust phenomena by exploring a fall in aggregate demand induced by a revision in expectations. According to the theory, favorable news about future productivity can set off a boom today and then a realization that productivity may be worse than expected can induce a bust without any actual reduction in productivity itself ever occurring. As such, this theory of business cycles addresses concerns with conventional theories, such as that booms and busts can happen without large changes in fundamentals and the idea that technological regress is not required to generate recessions.

The main idea is that optimistic news is expansionary but downward revisions can lead to busts. The authors explore several information structures: one in which the news can be wrong and another in which the news is right but can be incomplete. Cases when news can be wrong are generally referred to as “noise formulation.” It has proven challenging to make news-driven business cycles work in the context of standard business cycle models, a point first recognized by Barro and King (Quarterly Journal of Economics 1984) and later emphasized in Cochrane (Carnegie-Rochester Conference Series on Public Policy 1994).

Central to the theory is the ratio of capital stock to total factor productivity (TFP). The authors show that US recessions are almost always preceded by periods of capital excess, but mapping news and subsequent economic states is challenging because there are economic forces that are contradictory. Philosophically, the news view lies between two extremes in which the economy is driven by technological surprise, which would lead to a negative correlation between measures of the business cycle and the ratio of capital to TFP, and pure demand shocks, which would lead to a positive correlation between the business cycle and the ratio of capital to TFP.

The news view implies a simultaneous increase in both consumption and investment. This view is in contrast to a neoclassical setting in which the wealth effect of good news about future productivity causes households to desire more consumption, which leads to a reduction in labor supply and output and, theoretically, causes a bust today. This implied negative co-movement among macroeconomic aggregates (consumption and investment) is difficult to reconcile with the intuition that investment demand is an important driver of business cycles and the empirical evidence of a strong positive co-movement in the data. News shocks about future productivity do appear to induce positive co-movement among the major macroeconomic aggregates.

The news view of business cycles raises many questions that have only begun to be explored. Although the empirical evidence is mixed, theories that accommodate the notion of animal spirits and market sentiments are intuitively appealing. The main body of business cycle research has traditionally focused on the impact of future technology, demographic trends, taxes, monetary shocks, oil shocks, and so on rather than on news, which can encompass many diverse and co-integrated objects. The news view is appealing because it can explain why capital sometimes precedes TFP growth when markets are acting on news and other times when it lags because agents are reacting to news.