Business Cycle Implications of Capacity Constraints under Demand Shocks

Chacko George and Florian Kuhn
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Chacko George: FDIC

Review of Economic Dynamics, 2019, vol. 32, 94-121

Abstract: When capacity constraints limit the production of heterogeneous firms, demand shocks can endogenously generate a number of important business cycle regularities: recessions are deeper than booms, economic volatility is countercyclical, the aggregate Solow residual is procyclical and the fiscal multiplier is countercyclical. The model's main mechanism is that the share of firms at their production limit is strongly procyclical. A baseline calibration of a basic New Keynesian DSGE model with capacity constraints delivers more than 25% of the empirically observed asymmetry in output, 18% of the additional cross-sectional dispersion in recessions and around 25% of the additional aggregate volatility, and more than 50% of the fluctuations in the Solow residual. The model implies fluctuations in the fiscal multiplier of around 0.12 between expansions and recessions. (Copyright: Elsevier)

Keywords: Asymmetric business cycles; Economic volatility; Solow residual; Fiscal mutliplier; Capacity constraints (search for similar items in EconPapers)
JEL-codes: E13 E22 E23 E32 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (13)

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DOI: 10.1016/j.red.2019.01.001

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