Relative-Preference Shifts and the Business Cycle

This paper develops a two-sector dynamic general equilibrium model in which intertemporal fluctuations (and sectoral co-movement) are driven by idiosyncratic shocks to relative preferences among consumption goods. This class of shocks may be interpreted as shifts in consumer tastes. When shifts in preferences occur, consumers associate a new and different level of satisfaction to the same basket of consumption goods according to their modified preferences. This paper shows that if the initial composition of the consumption basket is sufficiently asymmetric, then a shift in relative preferences produces a "perception effect" strong enough to induce both intersectoral and intrasectoral positive co-movement of the main macroeconomic variables (i.e., output, consumption, investment, and employment). Furthermore, by extending the theoretical framework to a multisector model and introducing a more flexible structure for the relative-preference shock, we show that the parameter restrictions needed to observe sectoral co-movement after a relative-preference shock are much less severe. In particular, co-movement among most of the sectors emerges under general conditions, without requiring high levels of asymmetry in the consumption basket's composition and/or high aversion to risk. It is a welcome result that these findings are reached without introducing aggregate technology shocks, input-output linkages, or shocks perturbing the relative preference between aggregate consumption and leisure.