This project addresses two major inconsistencies between modern macroeconomic theories of business cycles and the empirical evidence. Positive shocks in the money supply depress both real and nominal interest rates, at least in the short run. Standard general equilibrium theory, with its emphasis on the alleged role of "sticky" nominal wages and prices in explaining the expansionary effects of monetary policy, would predict the opposite relationship. This project determines whether or not the explanation for this first inconsistency lies in an alternative (possibly complementary) channel, one which emphasizes the role of working capital in the production process and the liquidity effects of changes in the money supply. The second inconsistency is the phenomenon of procyclical productivity. Productivity tends to fall in downturns and rise in upturns. This seems to contradict neoclassical theories of business cycles because changes in aggregate output should conform to the law of diminishing marginal productivity, i.e., as the percentage of the labor force employed declines (increases), the productivity of the marginal worker should increase (decrease). This project determines whether or not procyclical productivity is due to the effect of labor hoarding and changes in capacity utilization. The project should provide new insights into the role of monetary policy as an impulse to postwar US business cycles. Specifically, it will improve our understanding of the role of liquidity effects as central components of the monetary transmission mechanism. The project analyzes the impact of monetary policy on financial markets and the observed dynamic co- movements between short term interest rates, output and the money supply. The project also improves our understanding of the dynamic co-movements between average productivity, hours worked and output. In this research the focus is on the role which labor hoarding and time varying capacity capital utilization rates play in generating the observed procyclicality of labor productivity and the Solow residual. This in turn leads to an investigation of how these phenomena impact on existing estimates of the role of technology shocks in generating economic fluctuations.
