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Abstract

Inspired by ideas presented in Pigou’s 1927 book on Industrial Fluctuations, Pigou cycles refer to economic fluctuations that are driven by changes in firms’ belief about the future profitability of current investment decisions. A recent literature has emerged exploring whether Pigou’s ideas may offer a reasonable explanation to business cycle episodes (revival inspired in part by the episode of the tech boom-bust of the 1990s). This literature has many challenges: theoretical, conceptual, and empirical. For example, what is the source of the change in beliefs, what are the transmission mechanisms, and are such forces empirically relevant? One of the immediate and less obvious challenges of this literature is to identify environments in which such changes in beliefs can actually cause business cycles, that is, positive comovement between investment, consumption, and employment. Although such a possibility sounds very intuitive, it is nontrivial to build fully specified (and reasonable) dynamic stochastic general equilibrium models in which changes in fundamentals that affect the future profitability of current investment actually generate business cycle phenomena. In a recent paper, Den Haan and Kaltenbrunner (2009) have shown that news about future productivity growth can generate business cycle phenomena in an environment in which jobs are subject to matching frictions. However, their results are somewhat fragile since they depended on, among others things, assuming a high degree of intertemporal elasticity of substitution in consumption. In the current paper, Den Haan and Lozej examine whether extending the analysis of the earlier paper to an international setting allows Pigou cycles to emerge for more reasonable parameter values. The main result of the paper is to show that an