Business Cycles with Cyclical Returns to Scale

We study business cycles with cyclical returns to scale. Contrary to tightly parameterized production functions (e.g., Cobb-Douglas and constant elasticity of substitution), we empirically identify strong input complementarity that leads to procyclical returns to scale. We, therefore, propose a flexible translog production function that allows complementarity-induced procyclical returns to scale. We integrate this function into a standard medium-scale dynamic stochastic general equilibrium (DSGE) model. Our estimated model with input complementarity (i) features procyclical returns to scale and acyclical price markups, (ii) better matches the cyclicality of factor shares, and (iii) significantly decreases the contribution of markup shocks to output fluctuations relative to those of the standard model.

Keywords: Business cycles, Translog production function, DSGE model, Returns to scale, Markup, Markup shocks

JEL Classification: C11, E23, E31, E32

Suggested Citation: Suggested Citation

Hyun, Jay and Kim, Ryan and Lee, Byoungchan, Business Cycles with Cyclical Returns to Scale (August 24, 2021). Available at SSRN: https://ssrn.com/abstract=3184050 or http://dx.doi.org/10.2139/ssrn.3184050