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Why Is Productivity Procyclical? Why Do We Care?

  • Susanto Basu
  • John Fernald

Productivity rises in booms and falls in recessions. There are four main explanations for this procyclical productivity: (i) procyclical technology shocks, (ii) widespread imperfect competition and increasing returns, (iii) variable utilization of inputs over the cycle, and (iv) resource reallocations. Recent macroeconomic literature views this stylized fact of procyclical productivity as an essential feature of business cycles because each explanation has important implications for macroeconomic modeling. In this paper, we discuss empirical methods for assessing the importance of these four explanations. We provide microfoundations for our preferred approach of estimating an explicitly first-order approximation to the production function, using a theoretically motivated proxy for utilization. When we implement this approach, we find that variable utilization and resource reallocations are particularly important in explaining procyclical productivity. We also argue that the reallocation effects that we identify are not biases' they reflect changes in an economy's ability to produce goods and services for final consumption from given primary inputs of capital and labor. Thus, from a normative viewpoint, reallocations are significant for welfare; from a positive viewpoint, they constitute potentially important amplification and propagation mechanisms for macroeconomic modeling.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7940.

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Date of creation: Oct 2000
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Publication status: published as Why Is Productivity Procyclical? Why Do We Care? , Susanto Basu, John Fernald. in New Developments in Productivity Analysis , Hulten, Dean, and Harper. 2001
Handle: RePEc:nbr:nberwo:7940
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