The effect of business cycles on growth: Keynes vs. Schumpeter

In contrast to recent 'neo-Schumpeterian' models, which argue that business cycles are good for growth, we develop a 'neo-Keynesian' model, where monopolistically competitive fir ms set prices and produce output in advance of the realization of (stochastic) monetary velocity in such a setting, there is an asymmetry in the effect of business cycles on income: recessions are bad, because the representative film is demand-constrained and its unsold output is wasted, but booms are not good because the firm is output-constrained and cannot produce any more output. A more severe business cycle thus reduces the expected income of a firm, and the expected return to investment, which reduces the growth rate of the economy. (JEL E32, E52, O41, L13).