Increasing Returns, Capital Utilization, and the E¤ects of Government Spending¤

We show that a one-sector real business cycle model with mild increasing returns-toscale and variable capital utilization is able to produce qualitatively realistic business cycles driven solely by aggregate demand shocks. In particular, a positive government spending shock can lead to simultaneous increases in output, consumption, investment, employment, labor productivity and the real wage. Our analysis illustrates a close relationship between this result and the recent literature that explores indeterminacy and sunspots in the real business cycle framework.