IMPERFECT TRANSMISSION OF TECHNOLOGY SHOCKS AND THE BUSINESS CYCLE CONSEQUENCES

Abstract

We investigate the business cycle effects of imperfect transmission of technology shocks within a basic real business cycle (RBC) model along two dimensions. First, we assume that agents cannot distinguish a temporary increase in productivity growth from a sustained increase in the underlying growth rate of productivity and instead must conduct signal extraction exercises and update beliefs about the source of aggregated shocks. Second, we propose a technology adjustment cost resulting in the slow diffusion of technological innovations into the production process. Both of these impediments to the transmission of technology result in a large initial wealth effect, increasing investment and hours less, relative to the usual RBC model without these frictions. Furthermore, each of these features is capable of producing a decline in hours on impact of the technology shock matching the negative response in hours found in the data by such works as Gali [American Economic Review89(1), 249–271 (1999)].