Two Essays on Business Cycle Models

Canonical business cycle theories are incapable of explaining some recent patterns in the data. My research explores generalizations of them towards a resolution of these empirical anomalies.;The first chapter, "An Empirical Evaluation of Sticky Information in a Two-Sector Model with Durable Goods," examines the empirical plausibility of the model developed by Kitamura and Takamura (2008), which presents a solution to the negative comovement problem discussed by Barsky, House and Kimball (BHK, 2007). Using the theoretical model presented by Kitamura and Takamura (2008), I compare impulse response functions in the model with those obtained from a structural VAR. Model-implied impulse response functions for sectoral output and inflation fit data well, for both durable and nondurable goods, over the period 1980Q1--2007Q4. Moreover, the minimum distance estimate of the degree of sticky information is 0.70, which is lower than the value used by Mankiw and Reis (2002) in their one-sector economy. This suggests that sticky information and firm-specific factors offer both a simple method to correct for the BHK puzzle and a useful strategy to generate plausible impulse responses in a two-sector economy.;In the second chapter, "A General Equilibrium Model with Banks and Default on Loans," I develop a model to explain aggregate business cycle patterns in the U.S. after 1990. A particular interest of this chapter is to analyze the interaction between banks and the real sector. During the recent financial crisis, banks reduced new business lending amidst concerns about borrowers' ability to repay. At the same time, firms facing higher borrowing costs alongside a worsening economic outlook reduced investment. My model explicitly introduces banks into a business cycle model. I assume that a banks' ability to raise deposits is constrained by a limited commitment problem and that, furthermore, loans to firms involve default risk. In this environment, changes in loan rates affect the size of the business sector. I explore how banks influence the behavior of households and firms and find that both productivity and financial shocks lead to counter-cyclical default and interest rate spreads.;I examine the implications of a government capital injection designed to mitigate the effect of negative productivity and financial shocks in the spirit of the Troubled Asset Relief Program (TARP). I find that the stabilizing effect of such policy interventions hinges on the source of the shock. In particular, a capital injection is less effective against aggregate productivity shocks because easing banks' lending stance only weakly stimulates firms' demand for loans when aggregate productivity falls. In contrast, a capital injection can counteract the adverse effect of financial shocks on the supply of loans.;Finally, I measure aggregate productivity and financial shocks to evaluate the role of each in the business cycle. I find that the contribution of aggregate productivity shocks in aggregate output and investment is large until mid-2008. Financial shocks explains 65% of the fall in investment and 55% of the fall in output in the first quarter of 2009.