Investment Shocks and Business Cycles

Abstract. The origins of business cycles are still controversial among macroeconomists. This paper contributes to this debate by studying the driving forces of uctuations in an estimated New Neoclassical Synthesis model of the U.S. economy. In this model, most of the variability of output and hours at business cycle frequencies is due to shocks to the marginal e ¢ ciency of investment. Imperfect competition and, to a lesser extent, technological frictions are the key to their transmission. Although labor supply shocks explain a large fraction of the uctuations in hours at very low frequencies, they are irrelevant over the business cycle. This nding is important because the microfoundations of these disturbances are widely regarded as unappealing. 1