Abstract

This paper adopts Keynes ' view that shocks to the marginal efficiency of investment are important for business fluctuations, but incorporates it in a neoclassical framework with endogenous capacity utilization. Increases in the efficiency of newly produced investment goods stimulate the formation of "new " capital and more intensive utilization and accelerated depreciation of "old " capital. Theoretical and quantitative analysis suggests that the shocks and transmission mechanism studied here may be important elements of business cycles. In the real-business cycle models of the type developed by Finn Kydland and Edward Prescott (1982), and John Long and Charles Plosser (1983), the cycles are generated by exogenous shocks to the production function. A stylized version of the main mechanism working in these models can be described as follows. Dynamic optimizing behavior on the part of agents in the economy implies that both consumption and investment react positively to these direct shocks to output. Since the marginal productivity of labor is directly affected, employment is also procyclical. The resulting capital accumulation provides a channel of persistence, even if the technology shocks are serially uncorrelated. Hence, these productivity shocks are able to generate, from a neoclassical framework, co-movements of macroeconomic variables and persistence of fluctuations that conform to those typically observed during business cycles. In contrast with the mechanism described above, where investment reacts to changes in output, the present paper adopts John Maynard Keynes ' (1936) view that it is shocks to the marginal efficiency of investment that are important for generating out-

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