Research Papers in Economics,
Stockholm University, Department of Economics

Abstract: This study investigates the implications of capital-skill complementarity

for the cyclical behavior of wage inequality. This is done in a dynamic general equilibrium model which extends the standard real business cycle model in three ways. First, the representative agent is replaced by two agent types, skilled and unskilled. Second, the standard, two-factor Cobb-Douglas production function is replaced by a more general, four-factor production function which allows for capital-skill complementarity. Third, the model includes both neutral and investment-specific technological change. The model successfully accounts for both the volatility and the cyclical behavior of the skill premium in the United States. The results of this study suggest that capital-skill complementarity may be an important determinant of wage inequality over the business cycle.

Keywords: business cycle; capital-skill complementarity; inequality; skill premium

JEL-codes: J31

33 pages, First version: July 16, 2002. Revised: September 1, 2003.

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