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Real business-cycle theory : Wisdom or whimsy?

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  • Eichenbaum, Martin

Abstract

This paper assesses the empirical plausibility of the view that aggregate productivity shocks account for most of the variability in post World War II US output. We argue that the type of evidence forwarded by proponents of this proposition is too fragile to be believable. First, our confidence in the evidence is fundamentally affected once we abandon the fiction that we actually know the true values of the structural parameters of standard Real Business Cycle (RBC) models. What the data are telling us is that, while productivity shocks play some role in generating the business cycle, there is simply an enormous amount of uncertainty about just what percent of aggregate fluctuations they actually do account for. The answer could be 70% as Kydland and Prescott (1989) claim, but the data contain almost no evidence against either the view that the answer is really 5% or that the answer is really 200%. Second, we show that point estimates of the importance of technology shocks are extremely sensitive to small perturbations in the theory. Allowing for labor hoarding behavior in an otherwise standard RBC model reduces the ability of technology shocks to account for aggregate fluctuations by 50%. This finding provides some support for the view that many of the movements in the Solow residual which are labelled as productivity shocks may be an artifact of labor hoarding type phenomena.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 15 (1991)
Issue (Month): 4 (October)
Pages: 607-626

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Handle: RePEc:eee:dyncon:v:15:y:1991:i:4:p:607-626

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Web page: http://www.elsevier.com/locate/jedc

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References

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  1. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  2. Robert E. Hall, 1986. "The Relation Between Price and Marginal Cost in U.S. Industry," NBER Working Papers 1785, National Bureau of Economic Research, Inc.
  3. Kydland, Finn E. & Prescott, Edward C., 1988. "The workweek of capital and its cyclical implications," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 343-360.
  4. Kydland, Finn E & Prescott, Edward C, 1991. "Hours and Employment Variation in Business Cycle Theory," Economic Theory, Springer, vol. 1(1), pages 63-81, January.
  5. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
  6. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  7. Gary D. Hansen, 1989. "Technical Progress and Aggregate Fluctuations," UCLA Economics Working Papers 546, UCLA Department of Economics.
  8. King, R.G. & Rebelo, S.T., 1989. "Low Frequency Filtering And Real Business Cycles," RCER Working Papers 205, University of Rochester - Center for Economic Research (RCER).
  9. Robert J. Gordon, 1980. "The "End-of-Expansion" Phenomenon in Short-run Productivity Behavior," NBER Working Papers 0427, National Bureau of Economic Research, Inc.
  10. Lawrence H. Summers, 1986. "Some skeptical observations on real business cycle theory," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 23-27.
  11. Lawrence J. Christiano & Martin Eichenbaum, 1990. "Current real business cycle theories and aggregate labor market fluctuations," Discussion Paper / Institute for Empirical Macroeconomics 24, Federal Reserve Bank of Minneapolis.
  12. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  13. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  14. Charles L. Evans, 1991. "Productivity shocks and real business cycles," Working Paper Series, Macroeconomic Issues 91-22, Federal Reserve Bank of Chicago.
  15. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  16. Robert E. Hall, 1989. "Invariance Properties of Solow's Productivity Residual," NBER Working Papers 3034, National Bureau of Economic Research, Inc.
  17. Leamer, Edward E, 1983. "Let's Take the Con Out of Econometrics," American Economic Review, American Economic Association, vol. 73(1), pages 31-43, March.
  18. Blanchard, Olivier Jean, 1989. "A Traditional Interpretation of Macroeconomic Fluctuations," American Economic Review, American Economic Association, vol. 79(5), pages 1146-64, December.
  19. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1990. "Labor Hoarding and the Business Cycle," NBER Working Papers 3556, National Bureau of Economic Research, Inc.
  20. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
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