Fickle Consumers versus Random Technology: Explaining Domestic and International Comovements

Viewing technology shocks as the primary source of business cycles has resulted in many "puzzles" or counter-factual predictions of general equilibrium theory with respect to international movements of output, consumption, investment, employment, and net exports (Backus, Kehoe and Kydland, JPE 1992). There are few puzzles, however, when aggregate demand rather than aggregate supply is the source of uncertainty. In particular, the stylized openeconomy business cycle regularities are what standard general equilibrium theory predicts once the usual suspect--fickle consumers--is held responsible for the business cycle. The finding that preference shocks explain both domestic and international business cycles suggests the possibility of a unified explanation of the business cycle and the seasonal cycle, as both types of fluctuations share a common source: recurrent shifts in preferences.