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Unformatted text preview: Noisy Business Cycles * George-Marios Angeletos MIT and NBER Jennifer LaO MIT November 19, 2009 Abstract This paper investigates an RBC economy that features dispersed information about the underlying real shocks, such as aggregate productivity shocks. We show how the heterogeneity of information can (i) contribute to significant inertia in the response of macroeconomic outcomes to such shocks; (ii) induce a negative short-run response of employment to productivity shocks; (iii) imply that productivity shocks explain only a small fraction of short-run fluctuations; (iv) imply that the bulk of such fluctuations are driven by noise; (v) formalize a certain type of demand shocks within an RBC economy; and (vi) generate cyclical variation in observed labor wedges and Solow residuals. Importantly, none of these properties requires significant uncertainty about the underlying fundamentals: they rest on the heterogeneity of information and the strength of general-equilibrium linkages. Finally, none of these properties are symptoms of inefficiency: apart from undoing monopoly distortions, no stabilization policy can improve upon the equilibrium allocations. JEL codes: C7, D6, D8. Keywords: Business cycles, fluctuations, heterogeneous information, informational frictions, noise, strategic complementarity, higher-order beliefs. * This paper was prepared for the 2009 NBER Macroeconomics Annual. We are grateful for their detailed feedback to our discussants, Christian Hellwig and Robert King; to the organizers, Daron Acemoglu, Kenneth Rogoff, and Michael Woodford; and to Liam Graham, Patrick Kehoe, and Ellen McGrattan. We also received useful comments from Philippe Bacchetta, Ricardo Caballero, V.V. Chari, Emmanuel Farhi, Jordi Gal, Mikhail Golosov, Guido Lorenzoni, Ricardo Lagos, Stephen Morris, Alessandro Pavan, Ricardo Reis, Robert Shimer, Robert Townsend, Harald Uhlig, Alwyn Young, Ivn Werning, and seminar participants at MIT, University of Wisconsin at Madison, UC San Diego, LSE, CREI, Toulouse School of Economics, Bocconi, Bank of Portugal, the Federal Reserve Bank of Minneapolis, the Federal Reserve Board, the World Bank, the 2009 Minnesota Workshop in Macroeconomic Theory, the 2009 conference in honor of Truman Bewley at the University of Texas, Austin, the 2009 meeting of the Society for Economics Dynamics, the 2009 NBER Summer Institute, the 2009 NBER Macroeconomics Annual, and the 2009 CEPR Hydra conference. Email: email@example.com , firstname.lastname@example.org . 1 Introduction There is a long tradition in macroeconomics, going back to Phelps (1970), Lucas (1972, 1975), Barro (1976), and King (1982), that breaks monetary neutrality by adding informational frictions....
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