Maintenance, Utilization, and Depreciation along the Business Cycle

In this paper we look at the behaviour of maintenance, utilization and physical depreciation over the business cycle. We do so within the context of a real business cycle model where the decisions of firms about physical capital utilization, maintenance, and improvement or scrapping are endogenous. We distinguish between labour input devoted to output production and labour input devoted to maintaining and improving or scrapping existing capital. Firms must first decide the total number of work hours and then how to allocate workers between output production and capital maintenance. The model encompasses the baseline real business cycle model, where the depreciation rate is fixed, or versions of that model where the depreciation rate is an exogenous stochastic process. It also encompasses versions of the real business cycle model where capital utilization is an explicit endogenous variable or enters implicitly a variable work effort. Our model is capable of providing a unified explanation of several stylized facts of business cycle behaviour, including (a) a low correlation between labour productivity and output, (b) a low correlation between wages and productivity and (c) a relatively strong correlation between real wages and hours worked. Making the business cycle propagation richer reduces the variance of the Solow residual needed to match output volatility.