Essays on Exogenous TFP Shocks and Business Cycles

Conventional technology shocks, or more specifically shifts in the current technology frontier, have been a popular explanation for business cycle fluctuations in macroeconomics. Critics have argued the need to understand the role of other types of technology shocks. In this vein, my research explores the role of shocks to the expectation of the future technology (news shocks) and shocks to the variance of the current technology process (uncertainty shocks).;In my first chapter, "Markups, Dynamic Demand Curves, News Shocks, and Business Cycles," I propose a model to solve the news shock "puzzle". In the standard neoclassical model, good news about the future---namely an expectation that future technology will improve---causes an output recession today. The good news, via the wealth effect, increases consumption and decreases equilibrium labor hours today. Lower labor hours lead to an output recession today. Also, lower output in the model leads to negative co-movement between consumption and investment today. This result is at odds with macroeconomic data where consumption and investment positively co-move. The main innovation of the model is the introduction of internal deep habits (ala Ravn et. al.) to consumers' behavior in the standard neoclassical model. Internal deep habits provide firms with an incentive to lower prices today in order to entice households to develop habits for their products, thus increasing their customer base. The deep habit formation leads to higher profits when technology and sales increase in the future. For example, AOL gave out free internet hours in response to expectations about increases in internet technology and increases in demand in the late 1990s in order to enlarge their customer base. Lower prices result in both higher consumption and higher labor hours. The latter effect is because lower prices result in higher real wages that help offset the wealth effect on labor hours. Additionally the model imposes investment adjustment costs; to offset the effects of habit on investment.;In my second chapter, "Can Endogenous Technology Choices Explain the Role of Uncertainty Shocks in Generating Business Cycles?" I develop a model to explain how uncertainty shocks can cause business cycle fluctuations. In the model, during times of high uncertainty, the representative agent, due to risk aversion motives, moves from a high risk/high return production process to a low risk/low return production process. This causes the firm level technology frontier to endogenously move inward, generating a recession. This endogenous movement in the technology frontier, due to the higher uncertainty, also implies that the model generates results that are very similar to the results for when the model economy only experiences a conventional technology shock, that explicitly shifts the technology frontier. This latter result highlights the possibility of identification problems between shocks to technology that shift the frontier versus those that change the variance of the technology process. The model also acts to dampen the effect of the uncertainty shock, thereby pointing to a systematic bias that can occur if the magnitude of uncertainty shocks is naively measured as the variance of TFP.