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Business cycles in a two-sector model of endogenous growth

Author

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  • Erik Canton

    () (CPB - Netherlands Bureau for Economic Policy Analysis, P.O. Box 80510, 2508 GM, The Hague, THE NETHERLANDS)

Abstract

This paper analyzes the impact of cyclical volatility on long-term economic growth: does growth increase or decrease with increased cyclical volatility? We construct a stochastic two-sector model of endogenous growth to analyze this question in detail. We will show that economic growth is higher in the presence of business cycles, since people devote more time to learning activities in an uncertain economic environment. Human capital is a hedge against future income uncertainty. Hence, the rate of economic growth will be higher in a stochastic environment. Based on a calibration of the model, we find that economic growth increases by 0.46%-point as a result of observed business cycle variability. When account is taken of the interaction between the model's general equilibrium and the cycle, welfare gains (measured in units of a permanent percentage increase in consumption) from eliminating business cycle volatility are approximately 1.87%.

Suggested Citation

  • Erik Canton, 2002. "Business cycles in a two-sector model of endogenous growth," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 19(3), pages 477-492.
  • Handle: RePEc:spr:joecth:v:19:y:2002:i:3:p:477-492
    Note: Received: January 25, 2000; revised version: November 3, 2000
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    Keywords

    Endogenous growth; Business cycles; Human capital accumulation.;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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