Why is Productivity Procyclical? A Model of Total Factor Productivity and its Role in the Business Cycle

Abstract:     
Total Factor Productivity (TFP) explains around a 70% of the business cycle fluctuations , yet its traditional interpretation as technology progress is not supported by the data , nor is it clear how its serially-persistent, mean-reverting behavior reconciles with neoclassical economics. This paper proposes to develop a neoclassical model of procyclical TFP by relaxing the traditional assumption of perfect competition, implicit in the Cobb-Douglas production function, and replacing it with a system where imperfect competition, and thus also economic rents, exist. An empirical example indicates that this model may be able to explain around two-thirds of the observed TFP variation.

Number of Pages in PDF File: 50

Keywords: Total Factor Productivity, TFP, Multifactor Productivity, MFP, Business Cycle, Economic Rents, Solow's Residual, Imperfect Competition

JEL Classification: E32, O47

working papers series