Business Cycles with Input Complementarity

Abstract

We study a business cycle with a Translog production function. We empirically identify a complementarity between labor and energy that leads to returns to scale, which is not compatible with the tightly parameterized production functions commonly used in the literature (Cobb-Douglas and CES). We—therefore—propose a flexible Translog production function that not only features complementarity-induced procyclical returns to scale but is also consistent with a balanced growth path. A simple calibrated business cycle model with the proposed production function generates strikingly data-consistent dynamics following demand shocks without relying on either nominal rigidities or countercyclical markups.