Increasing Returns and Unsynchronized Wage Adjustment in Sunspot Models of the Business Cycle

Kevin Huang () and Qinglai Meng

No 1007, Vanderbilt University Department of Economics Working Papers from Vanderbilt University Department of Economics

Abstract: A challenge facing the literature of equilibrium indeterminacy and sunspot-driven business cycle fluctuations based on increasing returns to scale in production is that the required degree of increasing returns for generating indeterminacy can be implausibly large and rise quickly with the relative risk aversion in labor. We show that unsynchronized wage adjustment via a relative wage effect can both lower the required degree of increasing returns for indeterminacy to an empirically plausible level and make it invariant to the relative risk aversion in labor. As a result, indeterminacy and sunspot-driven business cycle fluctuations may emerge for empirically plausible increasing returns regardless of the value of the relative risk aversion in labor. The impulse responses of our model to demand shocks under indeterminacy are reasonable in terms of matching the business cycle, and sunspot shocks become more important due to the presence of labor market frictions.

Keywords: Increasing returns; Unsynchronized wage adjustment; Relative wages; Relative risk aversion in labor; Indeterminacy; Sunspot (search for similar items in EconPapers)
JEL-codes: E12 E31 E52 (search for similar items in EconPapers)
Date: 2010-03
New Economics Papers: this item is included in nep-dge, nep-lab and nep-mac
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http://www.accessecon.com/pubs/VUECON/vu10-w07.pdf First version, March 2010 (application/pdf)

Related works:
Journal Article: Increasing returns and unsynchronized wage adjustment in sunspot models of the business cycle (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:van:wpaper:1007

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