An Equilibrium Model of the Business Cycle with Household Production and Fiscal Policy

Federal Reserve Bank of Minneapolis Research Department Staff Report 191

May 1995

An Equilibrium Model of the Business Cycle With Household Production and Fiscal Policy

Ellen McGrattan* Federal Reserve Bank of Minneapolis

Richard Rogerson* University of Minnesota and Federal Reserve Bank of Minneapolis

Randall Wright* University of Pennsylvania and Federal Reserve Bank of Minneapolis

ABSTRACT

We estimate a dynamic general equilibrium model of the U.S. economy that includes an explicit household production sector and stochastic fiscal variables. We use our estimates to investigate two issues. First, we analyze how well the model accounts for aggregate fluctuations. We find that household production has a significant impact and reject a nested specification in which changes in the home production technology do not matter for market variables. Second, we study the effects of some simple fiscal policy experiments and show that the model generates different predictions for the effects of tax changes than similar models without home production.

*We thank seminar participants at Cornell, Georgetown, North Carolina State, Northwestern, Pennsylvania, Queens, Virginia, and the Federal Reserve Banks of Atlanta and Minneapolis for input. Frank Diebold and Victor Rios-Rull also provided very useful comments. The National Science Foundation provided financial support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. W?|hL_U|L?

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