Monopolistic Competition, Business Cycles, and the Composition of Aggregate Demand

We develop a dynamic general equilibrium model with monopolistically competitive firms and endogenous markups and show the possibility of equilibria with persistent fluctuations driven by self-fulfilling revisions of expectations. For some parameter values such fluctuations are characterized by time series properties similar to those observed in U.S. postwar business cycles. In contrast with the existing literature our results do not rely on the presence of increasing returns or nominal rigidities. A key ingredient of the model is the link between markups and the composition of aggregate demand. Some econometric evidence on the latter is also reported. Journal of Economic Literature Classification Number: D43, D58, E32.