Homework in Macroeconomics II: Aggregate Fluctuations

This paper explores the implications of including home, or nomarket, production in an otherwise standard model of cyclical fluctuations. In particular, we generalize the stochastic growth model, or the real business cycle model, to include a household sector using the basic framework that labor economists have studied for some time. Symmetrically with the market sector, the household sector uses labor and capital to produce output according to a stochastic technology. We calibrate the model based on microeconomic evidence and long run considerations, simulate it, and examine its statistical properties. Our finding is that introducing home production significantly improves the quantitative performance of the standard model along several dimensions simultaneously. It also implies a very different interpretation of the nature of aggregate fluctuations.