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Real Business Cycle Theory: Wisdom or Whimsy?

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Author Info
Martin Eichenbaum

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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 shaw 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 stardard 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3432.

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Date of creation: Sep 1990
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Handle: RePEc:nbr:nberwo:3432

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22. [Downloadable!]
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  2. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July. [Downloadable!] (restricted)
  3. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November. [Downloadable!] (restricted)
  4. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1993. "Labor Hoarding and the Business Cycle," NBER Working Papers 3556, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Robert E. Hall, 1988. "The Relation Between Price and Marginal Cost in U.S. Industry," NBER Working Papers 1785, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Lawrence J. Christiano & Martin Eichenbaum, 1990. "Current real business cycle theories and aggregate labor market fluctuations," Working Paper Series, Macroeconomic Issues 90, Federal Reserve Bank of Chicago.
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  7. Hall, Robert E, 1988. "The Relation between Price and Marginal Cost in U.S. Industry," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 921-47, October. [Downloadable!] (restricted)
  8. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April. [Downloadable!] (restricted)
  9. 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. [Downloadable!] (restricted)
  10. Hansen, Gary D., 1997. "Technical progress and aggregate fluctuations," Journal of Economic Dynamics and Control, Elsevier, vol. 21(6), pages 1005-1023, June. [Downloadable!] (restricted)
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  11. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  12. Finn E. Kydland & Edward C. Prescott, 1989. "Hours and employment variation in business cycle theory," Discussion Paper / Institute for Empirical Macroeconomics 17, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  13. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November. [Downloadable!] (restricted)
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  14. 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).
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  15. Lawrence H. Summers, 1986. "Some skeptical observations on real business cycle theory," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 23-27. [Downloadable!]
  16. Blanchard, Olivier Jean, 1989. "A Traditional Interpretation of Macroeconomic Fluctuations," American Economic Review, American Economic Association, vol. 79(5), pages 1146-64, December. [Downloadable!] (restricted)
  17. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January. [Downloadable!] (restricted)
  18. Robert J. Gordon, 1979. "The "End-of-Expansion" Phenomenon in Short-Run Productivity Behavior," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 10(1979-2), pages 447-462. [Downloadable!]
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jim Malley & Ulrich Woitek, 2009. "Technology Shocks and Aggregate Fluctuations in an Estimated Hybrid RBC Model," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  2. David Altig & Charles T. Carlstrom, 1991. "Inflation, personal taxes, and real output: a dynamic analysis," Working Paper 9102, Federal Reserve Bank of Cleveland. [Downloadable!]
    Other versions:
  3. Beth Ingram & Eric M. Leeper, 1990. "Post econometric policy evaluation: a critique," International Finance Discussion Papers 393, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  4. V. Pandit, 2008. "Structural Modeling under Challenge," Working Papers id:1622, esocialsciences.com. [Downloadable!]
  5. Peter N. Ireland, 1999. "A method for taking models to the data," Working Paper 9903, Federal Reserve Bank of Cleveland. [Downloadable!]
    Other versions:
  6. Spree, Reinhard, 2002. "Business Cycles in History," Discussion Papers in Economics 6, University of Munich, Department of Economics. [Downloadable!]
  7. Adrian Pagan, 1999. "The Getting of Macroeconomic Wisdom," CEPR Discussion Papers 412, Centre for Economic Policy Research, Research School of Social Sciences, Australian National University. [Downloadable!]
  8. Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Carlos Borondo, 1994. "La rigidez nominal de los precios de la Nueva Economía Keynesiana: una panorámica," Investigaciones Economicas, Fundación SEPI, vol. 18(2), pages 245-288, May. [Downloadable!]
  10. R. Anton Braun & Charles L. Evans, 1994. "Seasonality and equilibrium business cycle theories," Staff Report 168, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  11. V. Pandit, 2001. "Structural Modelling Under Challenge," Working papers 98, Centre for Development Economics, Delhi School of Economics. [Downloadable!]
  12. Martin Eichenbaum, 1996. "Some comments on the role of econometrics in economic theory," Economic Perspectives, Federal Reserve Bank of Chicago, issue Jan, pages 22-31. [Downloadable!]
  13. Victor Zarnowitz, 1997. "Business Cycles Observed and Assessed: Why and How They Matter," NBER Working Papers 6230, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Chan Huh & Bharat Trehan, 1991. "Real business cycles: a selective survey," Economic Review, Federal Reserve Bank of San Francisco, issue Spr, pages 3-17. [Downloadable!]
  15. Alfonso Novales, 2002. "The Role of Simulation Methods in Macroeconomics," Documentos del Instituto Complutense de Análisis Económico 0227, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales. [Downloadable!]
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  16. Ertz, Guy, 1996. "Business Cycle Models and Stylized Facts in Germany," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 1997005, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES), revised 00 Apr 1997. [Downloadable!]
  17. Mordecai Kurz (contact author) & Hehui Jin & Maurizio Motolese, 2003. "The Role of Expectations in Economic Fluctuations and the Efficacy of Monetary Policy," CFS Working Paper Series 2003/42, Center for Financial Studies. [Downloadable!]
  18. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," NBER Working Papers 7534, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  19. Kumah, F.Y., 1996. "Common stochastic trends in the current account," Discussion Paper 84, Tilburg University, Center for Economic Research. [Downloadable!]
  20. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2008. "Are Structural VARs with Long-Run Restrictions Useful in Developing Business Cycle Theory?," NBER Working Papers 14430, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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