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Business cycle accounting

Author

Listed:
  • V. V. Chari
  • Patrick J. Kehoe
  • Ellen R. McGrattan

Abstract

We propose a simple method to help researchers develop quantitative models of economic fluctuations. The method rests on the insight that many models are equivalent to a prototype growth model with time-varying wedges which resemble productivity, labor and investment taxes, and government consumption. Wedges corresponding to these variables - efficiency, labor, investment, and government consumption wedges - are measured with data and then fed back into the model in order to assess the fraction of various fluctuations accounted for by these wedges. Applying this method to U.S. data for the Great Depression and the 1982 recession reveals that models with frictions which manifest themselves primarily as investment wedges are not promising for the study of business cycles. The efficiency and labor wedges together account for essentially all of the fluctuations, the investment wedge leads to an increase in output rather than a decline, and the government consumption wedge plays an insignificant role.

Suggested Citation

  • V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, . "Business cycle accounting," Staff Report, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:328
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    References listed on IDEAS

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    1. Francisco Covas & Wouter J. Den Haan, 2012. "The Role of Debt and Equity Finance Over the Business Cycle," Economic Journal, Royal Economic Society, vol. 122(565), pages 1262-1286, December.
    2. Brinca, P. & Chari, V.V. & Kehoe, P.J. & McGrattan, E., 2016. "Accounting for Business Cycles," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1013-1063, Elsevier.
    3. Albrecht Ritschl & Monique Ebell, 2007. "Real Origins of the Great Depression: Monopoly Power, Unions and the American Business Cycle in the 1920s," 2007 Meeting Papers 712, Society for Economic Dynamics.
    4. Gauti B. Eggertsson, 2012. "Was the New Deal Contractionary?," American Economic Review, American Economic Association, vol. 102(1), pages 524-555, February.
    5. Tiago Cavalcanti, 2007. "Business cycle and level accounting: the case of Portugal," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 6(1), pages 47-64, April.
    6. Jordi Galí & Mark Gertler & J. David López-Salido, 2007. "Markups, Gaps, and the Welfare Costs of Business Fluctuations," The Review of Economics and Statistics, MIT Press, vol. 89(1), pages 44-59, November.
    7. Dooyeon Cho & Antonio Doblas-Madrid, 2013. "Business Cycle Accounting East and West: Asian Finance and the Investment Wedge," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(4), pages 724-744, October.
    8. Simona Cociuba & Alexander Ueberfeldt, 2008. "Driving Forces of the Canadian Economy: An Accounting Exercise," Staff Working Papers 08-14, Bank of Canada.
    9. Yishay Yafeh & Mr. Kenichi Ueda & Mr. Stijn Claessens, 2010. "Financial Frictions, Investment, and Institutions," IMF Working Papers 2010/231, International Monetary Fund.
    10. Riccardo DiCecio, 2004. "Comovement: it's not a puzzle," 2004 Meeting Papers 113, Society for Economic Dynamics.
    11. Matheus Cardoso Leal & Marcio Issao Nakane, 2022. "Brazilian economy in the 2000’s: A tale of two recessions," Working Papers, Department of Economics 2022_20, University of São Paulo (FEA-USP).
    12. Anton Braun, R. & Esteban-Pretel, Julen & Okada, Toshihiro & Sudou, Nao, 2006. "A comparison of the Japanese and U.S. business cycles," Japan and the World Economy, Elsevier, vol. 18(4), pages 441-463, December.
    13. Dooyeon Cho & Dong-Eun Rhee, 2015. "An assessment of inflation targeting in a quantitative monetary business cycle framework: evidence from four early adopters," Applied Economics, Taylor & Francis Journals, vol. 47(32), pages 3395-3413, July.
    14. Mr. Fabian Valencia, 2008. "Banks’ Precautionary Capital and Persistent Credit Crunches," IMF Working Papers 2008/248, International Monetary Fund.
    15. Lee, Hangyu & Kim, Tae Bong, 2023. "The effectiveness of labor market indicators for conducting monetary policy: Evidence from the Korean economy," Economic Modelling, Elsevier, vol. 118(C).
    16. Engel, Charles, 2001. "Optimal Exchange Rate Policy: The Influence of Price Setting and Asset Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 518-541, May.
    17. Ellen R. M cG rattan & Lee E. Ohanian, 2010. "Does Neoclassical Theory Account For The Effects Of Big Fiscal Shocks? Evidence From World War Ii," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(2), pages 509-532, May.
    18. Ellen R. McGrattan, 2010. "Measurement with minimal theory," Quarterly Review, Federal Reserve Bank of Minneapolis, issue July, pages 2-13.
    19. Koehler-Geib,Fritzi & Hnatkovska,Viktoria, 2015. "Business cycles accounting for Paraguay," Policy Research Working Paper Series 7284, The World Bank.
    20. Claessens, Stijn & Ueda, Kenichi & Yafeh, Yishay, 2014. "Institutions and financial frictions: Estimating with structural restrictions on firm value and investment," Journal of Development Economics, Elsevier, vol. 110(C), pages 107-122.
    21. Brinca, Pedro, 2014. "Distortions in the neoclassical growth model: A cross-country analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 47(C), pages 1-19.
    22. Lawrence J. Christiano & Joshua M. Davis, 2006. "Two flaws in business cycle accounting," Working Paper Series WP-06-10, Federal Reserve Bank of Chicago.
    23. Mr. Jahangir Aziz, 2008. "Real and Financial Sector Linkages in China and India," IMF Working Papers 2008/095, International Monetary Fund.
    24. David M. Arseneau & Sanjay K. Chugh, 2007. "Bargaining, fairness, and price rigidity in a DSGE environment," International Finance Discussion Papers 900, Board of Governors of the Federal Reserve System (U.S.).
    25. Ritschl, Albrecht & Ebell, Monique, 2007. "Real Origins of the Great Depression: Monopolistic Competition, Union Power, and the American Business Cycle in the 1920s," CEPR Discussion Papers 6146, C.E.P.R. Discussion Papers.

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