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A news-driven business cycle is a positive comovement of consumption, output, labor, and investment from the news about the future. We show that nominal rigidities, especially sticky prices, can cause it in a medium-scale DSGE economy through countercyclical movements of the price-markup. We also find that sticky wages cannot generate it, but they amplify the effects of news shocks.

A news-driven business cycle (hereafter, NDBC) is a positive comovement of consumption, labor, investment, and output from a news shock about future productivity.

It is well known that the standard real business cycle model cannot generate it. Since the paper by Beaudry and Portier [^{1}.

In this paper, we focus on nominal rigidities as sources of NDBCs. We employ the model of Fujiwara, Hirose, and Shintani [

This paper is also closely related to the one by Kobayashi and Nutahara [

The rest of this paper is organized as follows. Section 2 introduces our model. In Section 3, it is shown that nominal rigidities, especially sticky prices, are sources of NDBCs. Section 4 draws our conclusions.

Our model is the same employed by Fujiwara, Hirose, and Shintani [

In our model, the representative household faces to the external habit persistence in the consumption and the adjustments costs of investments. The utilization rate of capital is variable. Nominal prices and wages are sticky and they are partially indexed to past inflation. Monetary authority follows a Taylor type nominal interest rate rule. Finally, there are many exogenous shocks that affect the economy.

The resource constraint is

where denote the output, the consumption, the investment, the capital utilization rate, and the government expenditure shock, respectively. denote the steady state share in output of consumption, investment and capital utilization cost, respectively.

The consumption Euler equation is

,(2)

where

denotes the parameter on the external habit;, the steady-state growth rate; and, the inverse of the intertemporal elasticity of substitution., , and denote the labor supply, the nominal interest rate, and the inflation rate, respectively.

The investment Euler equation is

where

denotes the discount factor of household;, the steady-state elasticity of the capital adjustment cost function; and, the investment-specific technology shock.

The capital Euler equation is

where

.

denotes Tobin’s Q and denotes the depreciation rate of capital.

The production function is

where denotes capital service;, productivity;, the share of capital in production; and, one plus the share of fixed costs in production.

The capital service, , is

where denotes the capital stock at the end of period t−1.

The utilization rate, , is determined by

where denotes a positive function of the elasticity of the capital utilization adjustment cost function and normalized to be between zero and one.

The evolution of capital stock, , is

where

The price markup, is

where denotes the wage rate.

The Phillips curve with partial indexation is

where

denotes the degree of indexation to past inflation;, the degree of price stickiness;, the curvature of the Kimball goods market aggregator; and, the price markup shock.

The rental rate of capital is

The wage markup, , is

where

and denotes the elasticity of labor supply with respect to the real wage.

The wage Phillips curve with partial indexation is

where

, denotes the degree of wage indexation;, the degree of the wage stickiness;, the curvature of the Kimball labor market aggregator; and denotes the wage markup shock.

The monetary policy is

where denotes monetary policy shock.

The evolutions of shocks are AR(1):

Technology shock is consist of unanticipated and anticipated components:

where denotes a news shock observed at period t−i.

We also consider the role of news shocks in the flexible price-wage economy. In this economy, price and wage markups are constant: and two Phillips curves (10) and (14) are removed from the baseline model.

Following Christiano, Ilut, Motto, and Rostagno [

We employ parameter values estimated by Fujiwara, Hirose, and Shintani [

They estimate parameters using the Bayesian technique2. Schmitt-Grohe and Uribe [

Positive comovements of consumption, labor, investment, and output occur, but these variables drop t = 4 since the news turns out to be false. Therefore, NDBCs are generated in the baseline model. However, in the flexible price-wage economy, NDBCs are not generated since consumption moves countercyclically.

In order to understand the mechanism, consider our model without capital utilization. By (9), (12) and (13), we obtain

This equation implies that the positive comovements of consumption and labor inputs is possible if the markups, , decrease sufficiently. High labor implies increase of output, and the news increases investment since the adjustment costs encourage current investment to prepare for the future. In our model, capital utilization is variable, but its response to the news shock is small and NDBCs are generated through the movements of the markups. On the contrary, in the flexible price-wage economy, markups are constant and NDBCs are not generated.

In the model of Christiano, Ilut, Motto, and Rostagno [

NDBCs are not generated in the baseline model if there are no nominal rigidities. Then, which rigidity is important for NDBCs? In order to address this question, we consider the sticky-price economy (wages are flexible) and the sticky-wage economy (prices are flexible). Other settings are the same as in the baseline economy.

In the sticky-wage economy, consumption moves countercyclically while NDBCs are generated in the stickyprice economy. Kobayashi and Nutahara [

While sticky wages are not sources of NDBCs, they are important since the responses of the economy with sticky wages to the news shock are large. Then, sticky wages amplify the effect of news shocks.

In this paper, we focused on nominal rigidities as sources of NDBCs. Our model is a medium-scale DSGE economy a la Smets and Wouters [

Our results imply that nominal price rigidity not only generate persistent responses to unexpected current shocks, but also drive booms and recessions in response to the news shock.

I would like to thank Keiichiro Kobayashi, Masaru Inaba, and an anonymous referee for their helpful comments and suggestions. Of course, the remaining errors are mine.