Procyclical Productivity in New Keynesian Models

We propose an easy-to-use search friction in the goods markets in medium-sized New Keynesian models. This friction allows increases in measured productivity in response to increases in expenditures via higher search effort from households. As a result markups can become procyclical and labor share countercyclical. Unlike in models that pose variable capital utilization and fixed costs to generate procyclical productivity, firms do not have to spend more to achieve it. We estimate the model matching impulse responses with Bayesian techniques and show superior performance of models with search frictions relative to the state of the art alternative models in the literature. Our estimates also display low fixed costs of production and lower Frisch elasticities.