AGENCY COSTS AND BUSINESS CYCLES

This paper develops a model with endogenous agency costs that is other wise quite similar to the canonical real business cycle model. The tra ditional assumption in the literature is that these agency costs arise in the production of investment goods. In contrast, this paper assume s that these costs are all encompassing in the sense that they arise i n the production of aggregate output. The paper explores both the impo rtance of the investment vs. output assumption for business cycle dyna mics, and the conditions under which these agency models can deliver a mplification and/or persistence. The paper has two principal conclusio ns. First, in terms of amplification and propagation, the output model performs worse than does the investment model. This arises because a variable distortion in the investment market has more of an impact tha n a comparable distortion in the output market. Second, in this model with optimal consumption choice by entrepreneurs, there is a clear ten sion between amplification and persistence.