Why is Productivity Cyclical? A Neoclassical Model of TFP Growth and the Business Cycle

Abstract:     
The Real Business Cycle (RBC) models a neoclassical system impacted by random changes on Total Factor Productivity (TFP) caused by exogenous "technology shocks." Its success in calibration tests confirms TFP's crucial role in the cycle yet, by assuming it exogenous, it requires its shocks being persistent (as they are indeed) without explaining why they should be so. At the same time, the model presents significant empirical issues which have led to exploring complementary, non-neoclassical hypotheses (e.g. bounded rationality or habit formation). This paper proposes to address these issues, instead, by lifting the assumption of perfect competition (and hence absence of economic rents) implicit in the RBC's constant-returns Cobb-Douglas production function. By allowing imperfect competition, we develop a model of TFP's procyclical persistence that incorporates the RBC's technology-shock-driven TFP as a particular case, yet opens the possibility of an interpretation of business cycles more consistent with observed stylized facts.

Number of Pages in PDF File: 57

Keywords: business cycle, total factor productivity, TFP, economic rents, RBC

JEL Classification: E32

working papers series