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Time-Separable Preference and Intertemporal-Substitution Models of Business Cycles

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  • Robert J. Barro
  • Robert G. King

Abstract

Time-separability of utility means that past work and consumption do not influence current and future tastes. This form of preferences does not restrict the size of intertemporal-substitution effects--notably, we can still have a strong response of labor supply to temporary changes in wages. However, there are important constraints on the relative responses of leisure and consumption to changes in relative-price and in permanent income. When the usual aggregation is permissible, time-separability has some important implications for equilibrium theories of the business cycle. Neglecting investment, we, find that changes in perceptions about the future -- which night appear currently as income effects -- have no influence on current equilibrium output. With investment included, no combination of income effects and shifts to the perceived profitability of investment will yield positive co-movements of output, employment, investment and consumption. Therefore, misperceived monetary disturbances or other sources of changed beliefs about the future cannot be used to generate empirically recognizable business cycles. Some richer specifications of intertemporal production opportunities may eventually yield more satisfactory answers. Because of the positive correlation between cyclical movements of consumption and work, equilibrium theories with time-separable preferences inevitably predict a procyclical behavior for the real wage rate, arising from shifts to labor's marginal product. Empirically, we regard the cyclical behavior of real wages as an open question. Aside from analyzing autonomous real shocks to productivity, we suggest that such shifts may occur as firms vary their capital utilization in response to intertemporal relative prices. However, we still lack some parts of a complete theory.

Suggested Citation

  • Robert J. Barro & Robert G. King, 1982. "Time-Separable Preference and Intertemporal-Substitution Models of Business Cycles," NBER Working Papers 0888, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0888 Note: EFG
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    1. Grossman, Herschel I, 1973. "Aggregate Demand, Job Search, and Employment," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1353-1369, Nov.-Dec..
    2. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
    3. Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
    4. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    5. McKenzie, Lionel W., 1979. "Optimal Economic Growth and Turnpike Theorems," Working Papers 267, California Institute of Technology, Division of the Humanities and Social Sciences.
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