Can News About the Future Drive the Business Cycle?

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  • 1 January 2006
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      • Published in RePEc
Abstract
In this paper we propose a model that generates an expansion in response to good news about future total factor productivity (TFP) or investment-specific technical change. The model has three key elements: variable capital utilization, adjustment costs to investment, and preferences that exhibit a weak short-run income effect on the labor supply. These preferences nest, as special cases, the two classes of utility functions most widely used in the business cycle literature. Even though our model abstracts from negative productivity shocks, it generates recessions that resemble those in the post-war U.S. economy. Recessions are caused not by contemporaneous negative shocks but by lackluster news about the future TFP or investment-specific technical change

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