Blog o’ Burns

Stockman, Alan. “Real Business Cycle Theory: a Guide, an Evaluation, and New Directions,” Federal Reserve Bank of Cleveland Economic Review, 1988 Quarter 4, Vol. 24, No. 4, pp. 24-47.

• purpose of real business cycle (RBC) models explain aggregate fluctuations in business cycles without reference to monetary policy
• explain fluctuations without discussion of market failures, fiscal policies, or disturbances to preferences or demographics
• concentration on technology shocks not a defining feature of RBC analysis
• Real business cycle analysis important and interesting:
  • evidence that monetary policy affects real output is weaker than economists had thought
  • even if monetary policy affect real output, evidence shows that it isn’t as dominant an influence on business cycles as previously thought
  • even if monetary disturbances play a major role in real-world business cycles, most economists believe that supply shocks and other nonmonetary disturbances (like oil price change, technological progress) also play an important role
    • designed to determine how real shocks affect output, employment, hours, consumption, investment, productivity, etc.
    • also try to show how disturbances in one sector of the economy at one time affect other sectors at later times
  • can determine how any disturbance (even monetary) spreads through different sectors of the economy over time
    • though monetary disturbances frequently set business cycles in motion, possible that the subsequent dynamics and characteristics of cycles would not be much different if caused by disturbances in tastes or technology
• characteristics include:
  • consumption varies less than output, which varies less than investment; consumer purchases of durables vary as much as investment while consumption of nondurables and services vary less and are positively correlated with output
  • hours worked are positively correlated with output and vary about as much
  • average product of labor is positively correlated with output and varies about half as much; correlation between productivity and output smaller than correlation between hours and output
• features of business cycles that this theory does not address
  • nominal money and real output are highly correlated
  • prices vary less than quantities
  • nominal prices are negatively correlated with output
  • real wages are acyclical or mildly procyclical
  • real exports, imports, and net exports are all correlated with output
• Stockman argues that quantitative differences across countries in business-cycle phenomenon and the cyclical behavior of international trade variables can provide support and evidence on RBC models
• Description of a Prototype RBC Model
• assume that: 1) households maximize the expected discounted value of a utility function defined over consumption and leisure; 2) constant-returns technology transforms labor and capital into output, which may be consumed or invested
• production function subject to random disturbances
• firms are perfectly competitive and there are no taxes, public goods, externalities, or restriction on the existence of markets
• maximization decisions involve tradeoffs: consumption vs. investment; labor vs. leisure
• given some particular production and utility functions, an initial stock of capital, and random disturbances, the model can be solved for decision rules and thereby probability rules for all of the endogenous variables –> probability rules yield variances, covariances, and other indicators that can be compared against real world data
• criticized over arbitrary choices of utility and production parameters and exogenous stochastic processes
• Some Variation on the Prototype Model
• Kydland and Prescott included time to build (non-instantaneous investment), variable utilization of capital, lagged effects of leisure on utility, and imperfect information about productivity
• Hansen added lotteries on employment and assumed people either worked full time or not at all; optimal outcome may be to have some people working full time and others not; who works and who doesn’t is completely random and exogenous to the system
• Restrictions on Parameters and Functional Forms
• fraction of total time spent working
• psychological discount rate
• rate of capital depreciation
• marginal rate of substitution over time in consumption, which corresponds to the the relative risk aversion for intertemporally separable utility functions
• marginal rate of substitution over time in leisure
• labor’s share of total GNP
• variance and autocovariances of productivity shocks
• Business Cycles and Long-Run Growth
• some economists have recently argued that the traditional distinction between issues of long-run secular growth and short-term GNP fluctuations should be altered to show that business cycles and long-run growth are intertwined
• given assumption that monetary disturbances only have temporary effects on real output, real disturbances more important source of output fluctuations
• dynamics of GNP during recessions much different than during nonrecession periods