Stochastic Demands, Fixed Costs and Time Varying Solow Residual

Abstract

The paper analyzes, in a general equilibrium framework under the assumption of fixed costs and microlevel uncertainty, the impact of transitory aggregate shocks on the behavior of macroeconomic variables. We establish that transitory shocks can have persistent effects and can cause significant welfare losses. In addition, the Solow Residual is shown to fluctuate even though the technological frontier is time invariant and factors are fully employed. Finally, the paper resolves apparently contradictory observations and shows that recessions are simultaneously times of cleansing and sullying.