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Business cycle accounting

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

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.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 328.

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Date of creation: 2006
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Publication status: Published in Econometrica (Vol. 75, No. 3, May 2007, pp. 781-836)
Handle: RePEc:fip:fedmsr:328
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