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Two Flaws In Business Cycle Accounting

  • Lawrence J. Christiano
  • Joshua M. Davis

Using 'business cycle accounting' (BCA), Chari, Kehoe and McGrattan (2006) (CKM) conclude that models of financial frictions which create a wedge in the intertemporal Euler equation are not promising avenues for modeling business cycle dynamics. There are two reasons that this conclusion is not warranted. First, small changes in the implementation of BCA overturn CKM's conclusions. Second, one way that shocks to the intertemporal wedge impact on the economy is by their spillover effects onto other wedges. This potentially important mechanism for the transmission of intertemporal wedge shocks is not identified under BCA. CKM potentially understate the importance of these shocks by adopting the extreme position that spillover effects are zero.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12647.

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Date of creation: Oct 2006
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Handle: RePEc:nbr:nberwo:12647
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