Oligopolistic Business Cycle Amplification∗

We develop a tractable dynamic general equilibrium model with a continuum of different industries, each comprising a finite number of strategic price-setting firms. Each industry coordinates on profit-maximizing markups taking as given the strategic behavior of all other industries. The strategic behavior of all firms jointly determines the level of aggregate consumption in each state, which in turn determines the pricing kernel of the economy. Deviations from efficient consumption are determined state-by-state by the crosssectional heterogeneity of markups across industries. Heterogeneity of markups rather than the level matters, as it distorts relative goods prices and hence causes deviations from the efficient allocation of labor to industries in the economy. Markups in one particular industry can either be procyclical or countercyclical depending on the risk aversion of the representative agent and the correlation of sector-specific productivity with aggregate consumption. General equilibrium in the model is shown to exist under general conditions. Strategic interaction between firms amplifies business cycles, and the equilibrium outcome can be very sensitive to small changes in long-term growth rates whereas temporary changes have only marginal impact. ∗Preliminary version. Comments are welcome. We thank Kyle Bagwell, Nicolae Garleanu, Zhiguo He, Anders Karlsson, Debbie Lucas, Hanno Lustig, Stephanie Schmitt-Grohe, and Robert Staiger for very helpful comments and discussions. We also appreciate feedback from seminar participants at Aarhus University, Goethe University, MIT, University of Illinois, Urbana Champaign, University of Southern California, and the 2012 Jackson Hole finance conference. All authors are at the Haas School of Business, UC Berkeley.