General Equilibrium and Business Cycles

The general equilibrium models in this paper, with complete markets, can give the major features of business cycles. The models include real investment, but information is costless and is available to everyone at the same time. Fluctuations in the match between resources and wants across many sectors create major fluctuations in output and unemployment, because moving resources from one sector to another is costly. Fluctuations in the demand for the services of durable goods causes much larger fluctuations in the output of durables, and causes unemployment that takes the form of temporary layoffs. Since specialized factors cooperate in producing goods and services, it makes sense to lay people off in groups rather than lowering wages and waiting for them to quit. Similarly, a vacancy is created when a specialized factor is missing from such a group. Technology comes with varying levels of risk and expected return associated with the degree of specialization. More specialization means more severe fluctuations and a higher average level of unemployment, along with a higher average level of output and growth. Monetary policy, interest rates, and fiscal policy have no special roles to play in the model.