Real Business Cycles

Real Business Cycles - Real Business Cycles A Legacy of...

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RSS March 1999 issue Are policies exacerbating the swings in business cycles? Satyajit Chatterjee - Senior Economist and Research Advisor, Federal Reserve Bank of Philadelphia Published March 1, 1999 Tweet Share Email Print Business cycles have troubled market-oriented economies since the dawn of the industrial age. The upward march of living standards in capitalistic countries has been repeatedly punctuated by periods of markedly high unemployment rates and slow growth or an outright decline in the living standard of the average person. This alternating pattern of boom and bust is what the term business cycle means. In an article published in 1986, Edward Prescott forcefully argued that during the post-World War II period, business cycles in the United States mostly resulted from random changes in the growth rate of business- sector productivity. 1 He showed that upswings in economic activity occurred when productivity grew at an above-average rate and downswings occurred when productivity grew at a below-average rate. Prescott challenged the dominant view that business cycles are caused by monetary and financial disturbances. According to that view, upswings in economic activity result from unexpectedly rapid increases in the supply of money, while downswings result from slow growth or a fall in the money supply. In contrast, Prescott and his collaborators presented evidence that business cycles of the sort seen during the postwar era would occur even if there were no monetary or financial disturbances. John Long and Charles Plosser coined the term real business cycles to describe business cycles whose proximate causes are random changes in productivity. 2 Without a doubt, the most controversial aspect of real-business-cycle theory is its implications for countercyclical monetary and fiscal policies. Real-business-cycle theory appears to ascribe no importance to existing countercyclical policies. Moreover, it implies that some policies aimed at reducing the severity of business cycles are likely to entail more costs than benefits. Both implications contradict long-held views. Indeed, these policy implications strike many economists as so outrageous that they simply dismiss real-business-cycle theory as false. Yet, the theory has successfully countered the many objections leveled against it. 3 As a result, macroeconomists are beginning to take it more seriously. Of course, countercyclical policies are of paramount importance to the Federal Reserve System. As real-business-cycle theory gains increasing acceptance among economists, an understanding of its policy implications becomes crucial. Consequently, this article briefly describes real-business-cycle theory, then Real Business Cycles: A Legacy of Countercyclical Policies - The Region... http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id...
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