Sector-specific Markup Fluctuations and the Business Cycle

Abstract

The counter-cyclicality in the relative price of equipment investment which is observed in the U.S. has been attributed to equipment-specific pro- ductivity shocks. Cross-country evidence indicates that a number of coun- tries experience sizeable delays between a surge in equipment production and a fall in its relative price, which is dfficult to reconcile with sector- specific shocks. I show that in the presence of sector specific, time-varying markups, relative price movements arise as a direct consequence of con- sumption smoothing, even if all shocks are aggregate, while barriers to firm entry lead to delays in relative price responses. A calibrated version of the model explains around one-third of the relative price fluctuations which are observed in the U.S., as well as the qualitative differences in the behaviour of this relative price across countries.