Rajeev Dhawan and Karsten Jeske
Working Paper 2006-9
August 2006
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So far, the literature on dynamic stochastic general equilibrium models with energy price shocks uses energy on the production side only. In these models, energy shocks are responsible for only a negligible share of output fluctuations. We study the robustness of this finding by explicitly modeling private consumption of energy at the household level in addition to energy use at the firm level to account for total energy use in the economy. Additionally, we distinguish between investment in consumer durables and investment in capital goods. The model economy is calibrated to match total energy use and durable goods consumption as observed in the U.S. data. Simulation results indicate that, despite higher total energy use, this economy has an even smaller proportion of output fluctuations attributable to energy price shocks. Productivity shocks continue to be the primary force behind business cycle fluctuations. The driving force behind our results is that the household now has the flexibility to rebalance its investment portfolio. Specifically, the energy price hike is absorbed by reducing durable goods investment more than investment in capital goods, thereby cushioning the hit to future production at the expense of current consumption. Hence, our model better matches the consumption volatility observed in the data.
JEL classification: E32, Q43
Key words: energy prices, business cycles, durable goods
The authors thank John Duffy, James Hamilton, Erwan Quintin, Pedro Silos, Tao Zha, and seminar participants at the Federal Reserve Bank of Atlanta, the 2006 Western Economic Association meetings, and the 2006 Society of Economic Dynamics summer meetings for helpful comments and discussion. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.
Please address questions regarding content to Karsten Jeske, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8825, karsten.jeske@atl.frb.org, or Rajeev Dhawan, Robinson College of Business, Georgia State University, Atlanta, GA 30303, ecfrmd@langate.gsu.edu.
For further information, contact the Public Affairs Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8020.