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Separating the Business Cycle from Other Economic Fluctuations

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  • Robert E. Hall

Abstract

Macroeconomists%u2014%u2014especially those studying monetary policy%u2014%u2014often view the business cycle as a transitory departure from the smooth evolution of a neoclassical growth model. Important ideas contributed by Friedman, Lucas, and the developers of the sticky-price macro model generate this type of aggregate behavior. But the real-business cycle model shows that the neoclassical model implies anything but smooth growth. A purely neoclassical model, devoid of anything resembling a business cycle in the sense of transitory departures from neoclassical equilibrium, nevertheless explains most of the volatility of GDP growth at all frequencies. Monetary policymakers looking to a neoclassical model to provide the neutral levels of key variables-potential GDP, the natural rate of unemployment, and the equilibrium real interest rate, need to solve a complicated and controversial model to find these constructs. They cannot take average or smoothed values of actual data to find them. Further, low-frequency movements of unemployment suggest a failure of the basic idea that departures from the neoclassical equilibrium are transitory. I discuss new theories of the labor market capable of explaining the low-frequency movements of unemployment. I conclude that monetary policymakers should not try to discern neutral values of real variables. Some branches of modem theory do not support the concepts of potential GDP, the natural rate of unemployment, and the equilibrium real interest rate. Even the theories that do support the concepts suggest that measurement in real time is impractical.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11651.

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Date of creation: Oct 2005
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Publication status: published as The Greenspan Era: Lessons for the Future, proceedings of the Federal Reserve Bank of Kansas City Symposium, August 2005, pp. 133-179.
Handle: RePEc:nbr:nberwo:11651

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Cited by:
  1. Rochelle M. Edge & Michael T. Kiley & Jean-Philippe Laforte, 2007. "Natural rate measures in an estimated DSGE model of the U.S. economy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2007-08, Board of Governors of the Federal Reserve System (U.S.).
  2. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan Standard," Working Papers, Princeton University, Department of Economics, Center for Economic Policy Studies. 88, Princeton University, Department of Economics, Center for Economic Policy Studies..
  3. Mark W. Watson, 2007. "How accurate are real-time estimates of output trends and gaps?," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Spr, pages 143-161.
  4. Silke Tober & Tobias Zimmermann, 2008. "Monetary policy and commodity price shocks," IMK Working Paper 16-2008, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
  5. Jeffrey R. Campbell & Spencer Krane, 2005. "Consumption-based macroeconomic forecasting," Economic Perspectives, Federal Reserve Bank of Chicago, Federal Reserve Bank of Chicago, issue Q IV, pages 52-70.
  6. Stijn Claessens & M. Ayhan Kose & Marco E. Terrones, 2009. "What happens during recessions, crunches and busts?," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 24, pages 653-700, October.
  7. Gerald Epstein, 2007. "Central banks as agents of employment creation," Working Papers, United Nations, Department of Economics and Social Affairs 38, United Nations, Department of Economics and Social Affairs.
  8. James Laurenceson, 2011. "The Persistence Characteristics of Output Growth in China: How Important is the Business Cycle?," Discussion Papers Series 430, School of Economics, University of Queensland, Australia.
  9. Hjelm, Göran & Jönsson, Kristian, 2010. "In Search of a Method for Measuring the Output Gap of the Swedish Economy," Working Paper, National Institute of Economic Research 115, National Institute of Economic Research.

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