This paper considers a general framework with two characteristics: (i) hiring and separation decisions are not always efficient and the degree of inefficiency varies with the external shocks and (ii) production requires a fixed cost. If both conditions are satisfied, then fluctuations are costly. In particular, business cycle fluctuations are costly and this is true when inefficiencies are pro as well as countercyclical. Using an estimate of the difference between cyclical GDP during an expansion and cyclical GDP during a recession, we find that the cost of business cycles can easily exceed 2% of GDP per period, which exceeds conventional estimates.
(Joint work with Wouter den Haan.)