Journal of Economic Behavior and Organization 22 (1993) 161-187. North-Holland Investment confidence, corporate debt and income fluctuations* D. Delli Gatti Uniuersitci Cattolica, 20123 Milano, Italy M. Gallegati and L. Gardini Uniuersitri di Urbino, 61029 Urbino (PS), Italy Received July 1990, tinal version received April 1992 In this paper we present a macroeconomic model with New Keynesian features which endogenously generates dynamic paths of income and the stock of corporate debt of a cyclic and chaotic nature. From the market clearing condition on goods and money markets we derive the dynamic paths of income and corporate debt whose stability properties depend upon the propensity to invest out of the flow of internally generated funds, which in turn is a positive function of income. If it is relatively ‘low’, the dynamic paths on income and corporate debt converge to their steady-state long-run values. When the propensity to invest is neither too ‘low’ nor too ‘high’, the system can exhibit either bounded cycles or chaotic dynamics. Finally, if it exceeds a critical upper value, an explosive growth of debt occurs and a financial crisis is likely to ensue. 1. Introduction The real Business Cycle (RBC) hypothesis [Long and Plosser (1983)], explains business fluctuations as optimal responses of a macroeconomic system in Walrasian equilibrium to random shocks of a technological nature. It is based on the Frisch-Slutsky view according to which fluctuations are caused by exogenous shocks imposed upon an inherently stable economic system. In a series of recent papers [Day and Shafer (1985, 1987), Day (1989), Day and Lin (1991)], Hansen-Samuelson (endogenous) approach to business cycle Correspondence to: Prof. Laura Gardini, Istituto di Scienze Economiche, UniversitL di Urbino, Piazza della Repubblica 3, 61029 Urbino (PS), Italy. *We are indebted to M. Amendola, W. Brock, R. Day, H. Minsky, J. Stiglitz and an anonymous Referee for their many stimulating comments and criticisms. Financial support from the Italian Ministry of Scientific Research (MURST) is gratefully acknowledged. This paper stems from the MURST Research Project on ‘Nonlinear Economic Models and Complex Dynamics’. Domenico Delli Gatti wrote sections 1 and 2, Mauro Gallegati sections 3 and 5, Laura Gardini section 4. 0167-2681/93/$06.00 0 1993-Elsevier Science Publishers B.V. All rights reserved