Free entry and business cycles under the influence of animal spirits$

We provide a business cycle model in which endogenous markup fluctuations are the main driving force. These fluctuations occur due to some form of ‘animal spirits’, impelling firms in their entry-exit decisions within each sector. By contrast to existing models of the business cycle emphasizing the role of animal spirits, we do not rely on the sink property of the equilibrium to generate indeterminacy. Hence, while our model does pretty well in accounting for the main features of US business cycles, it avoids several criticisms addressed to these former models, concerning either their dependence upon strongly increasing returns, too high markups, or their implication of countercyclical movements of consumption. r 2005 Elsevier B.V. All rights reserved