Efficiency wages, consumption inequality and self-fulfilling business cycles

We propose a model of business cycles for an economy that is characterized by involuntary unemployment and being dependent on energy imports. The presence of both factors increases aggregate volatility in a well-defined way: empirically reasonable degrees of income insurance and cost shares of imported energy generate equilibrium indeterminacy making the economy potentially subject to sunspots. The underlying force for this result is the heterogeneity in consumption levels of the employed and unemployed individuals. We estimate the model and find that its specification with indeterminacy has a marginal data density significantly higher than the determinacy version for the Great Moderation period as well as since the Great Recession. We back out a series for non-fundamental changes in expectations. This series of sunspots is highly correlated with a common measure of confidence and, through the lens of our theory, these sunspot shocks have played a non-trivial role in driving the U.S. business cycle.