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Business Cycle Implications of Capacity Constraints under Demand Shocks

Author

Listed:
  • Chacko George

    (FDIC)

  • Florian Kuhn

    (Binghampton University)

Abstract

When capacity constraints limit the production of heterogeneous firms, demand shocks can endogenously generate a number of important business cycle regularities: recessions are deeper than booms, economic volatility is countercyclical, the aggregate Solow residual is procyclical and the fiscal multiplier is countercyclical. The model's main mechanism is that the share of firms at their production limit is strongly procyclical. A baseline calibration of a basic New Keynesian DSGE model with capacity constraints delivers more than 25% of the empirically observed asymmetry in output, 18% of the additional cross-sectional dispersion in recessions and around 25% of the additional aggregate volatility, and more than 50% of the fluctuations in the Solow residual. The model implies fluctuations in the fiscal multiplier of around 0.12 between expansions and recessions. (Copyright: Elsevier)

Suggested Citation

  • Chacko George & Florian Kuhn, 2019. "Business Cycle Implications of Capacity Constraints under Demand Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 32, pages 94-121, April.
  • Handle: RePEc:red:issued:17-108
    DOI: 10.1016/j.red.2019.01.001
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    Cited by:

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    2. Lautenbacher, Stefan, 2020. "Subjective Uncertainty, Expectations, and Firm Behavior," MPRA Paper 103516, University Library of Munich, Germany.
    3. Biolsi, Christopher, 2017. "Nonlinear effects of fiscal policy over the business cycle," Journal of Economic Dynamics and Control, Elsevier, vol. 78(C), pages 54-87.
    4. Christoph Boehm & Nitya Pandalai Nayar, 2018. "Are supply curves convex? Implications for state-dependent responses to shocks," 2018 Meeting Papers 336, Society for Economic Dynamics.

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    More about this item

    Keywords

    Asymmetric business cycles; Economic volatility; Solow residual; Fiscal mutliplier; Capacity constraints;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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