Rent-Sharing and Expectation Driven Business Cycles

Abstract

Traditionally, standard business cycle models fail in generating the proper co-movements necessary to conform to empirical observations in response to positive news. This paper explores the potential of adding a new mechanism to the class of models that can generate these co-movements.Specifically, the mechanism that is proposed here is based on the idea of rent-sharing within a labour reciprocity framework. Reciprocity enters the model via the introduction of endogenous effort into the household’s preferences and based on the degree of wage generosity, the household determines its provision of effort to the firm. While the base model slightly improves the results of standard models, it too fails in generating the required co-movements in response to positive news. The model is then extended to incorporate variable capacity utilization and costly capital accumulation. With these added features, the model is able to generate boom in output, consumption, and hours worked, however, it still fails in generating a boom in investment.