Increasing Returns, Durables and Economic Fluctuations

We describe an economy where a durable good is produced with an increasing returns to scale technology. Equilibria in this economy take the form of business cycles in which consumption fluctuates too much and is too low on average. A 2-sector version of this economy with imperfect credit and immobile labor also exhibits aggregate business cycles, in which outputs and labor inputs in different sectors move together. The model is consistent with a broad range of evidence on economic fluctuations.