By Martin Ellison and Andrew Scott
Cycles in economic activity have been evident for most of recorded history, yet economists are still struggling to explain convincingly the patterns revealed in these cycles. Keynesian macroeconomics was an attempt in the 1930s to show how aggregate demand failure could generate recessions, from which there would be no rapid or automatic recovery. However, this relied upon arbitrary assumptions about rigidities in prices and wages that few find plausible today. A more recent agenda within macroeconomics has focused on building explicit dynamic models of the economy that can potentially replicate the observed patterns of business cycles in advanced industrial economies. The current paper offers a contribution to this agenda.
Sticky prices and volatile output