Relative-preference shifts and the business cycle

William Addessi and Francesco Busato ()

No 132, Working Papers in Public Economics from Department of Economics and Law, Sapienza University of Roma

Abstract: This paper develops a two-sector dynamic general equilibrium model in which intertemporal fluctuations (and sectoral comovement) are driven by idiosyncratic shocks to relative preferences between consumption goods. This class of shocks may be interpreted as shifts in consumer tastes. When shifts in preferences occur, consumers associate a new and different level of satisfaction to the same basket of consumption goods according to the modified preferences. The paper shows that, if the initial composition of the consumption basket is sufficiently asymmetric, a shift in relative preferences produces a so strong ""perception effect"" capable of inducing inter and intra sectoral positive comovement of the main macroeconomic variables (i.e., output, consumption, investment, and employment). Furthermore, extending the theoretical framework to a multi-sector model and introducing a more flexible structure of the relative preference shock, we show that the parameter restrictions, necessary in order to observe sectoral comovement after a relative preference shock, are much less severe. In particular, the comovement between the most of the sectors emerges under general conditions, without requiring high asymmetry in the composition of the consumption basket and/or high aversion to risk. It is a welcome result that these findings are reached without introducing either aggregate technology shocks or input-output linkages, or shocks perturbing the relative preference between aggregate consumption and leisure.

Keywords: Demand Shocks; Two-sector Dynamic General Equilibrium Models. (search for similar items in EconPapers)
JEL-codes: E32 F11 (search for similar items in EconPapers)
Pages: 30
Date: 2010-05
References: Add references at CitEc
Citations: View citations in EconPapers (3)

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Journal Article: Relative-Preference Shifts and the Business Cycle (2010)
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