Time-Varying Skewness and Real Business Cycles

In the context of a quantitative real business cycle (RBC) model, we document that shocks to the higher-order moments, especially the skewness, of productivity can have large first-order effects on business cycles. We augment a standard small open economy RBC model with a new feature: a discrete regime switching between higher-order moments of total factor productivity shocks between an unrest state and a quiet state. To map the theory to data, we exploit an extensive database of mass political unrest around the world. We calibrate the model to the observed increases in the volatility and skewness of the growth rates of key economic variables during episodes of unrest. The calibrated model shows that increases in negative skewness play an important role in explaining the observed first-order decline in economic activities.