Steps 1, 2, 3, 5 & their unwinding through time generate a cycle for 𝑌 , ? and 𝐼 . Step 4 is necessary to get fluctuations in employment (hours). Criticisms of the RBC model: Criticism 1: The impulse & propagation mechanism Little evidence about the source & nature of technological shocks (business cycle driver). The model also required technological regress to produce business cycles. Later, the scope of what constitutes a tech. shock was widened (e.g. to include changes to the regulatory system), but criticisms of inconsistencies with l/run data remained. The propagation of the tech. shocks also requires a very persistent initial impulse, but there is no economic justification or micro foundation for this. Without high persistence, the RBC fits the data poorly.
12 Criticism 2: The labour market The original RBC relies on the intertemporal substitution between labor & leisure to drive business cycles. Following the model, aggregate hours & productivity should vary closely with output. This would imply that hours per worker vary closely with output and that real wage is strongly procyclical. Aggregate hours worked is more variable than productivity in the data, which is not supportive of the model. Fig 16.2 (slide 9) shows that employment (not hours) varies more with 𝑦 , suggesting that change in employment is a key driver of changes in aggregate hours. Moreover, 𝑤 is shown to be acyclical/ mildly procyclical in the data, which is more in line with the model in Ch. 2 where 𝐴? shocks shift 𝑤 around the equ'm. The RBC was better reconciled with data using some modifications, e.g. using a model of indivisible labour & allowing 𝐺 to influence labour mkt dynamics. Finally, micro estimations of the intertemporal elasticity of labour supply also found that it was too small to account for the fluctuations in actual hours. Criticism 3: The Modelling Approach Earlier models only used identical representative agents. Absence of heterogeneity or aggregation limited the quantitative accuracy of the model’s predictions. The Impacts of RBC Modelling: 1. Increased the focus of models on microfoundations. (Models now more robust, but choice of microfoundations remains open to dispute).
13 2. Since RBCs are microfounded, they are better able to analyze the causal effects of policy (assuming the specified agent behavior in the model is a good representation of the economy). 3. It refocused macroeconomics on the real causes of business cycles. 4. The device of building a model economy is a potentially valuable methodology – e.g. the NK DSGE models utilize more realistic microfoundations, and they are useful to quantify the welfare implications of economic policy.
REAL BUSINESS CYCLE THEORY Rational expectations provided a theoretical basis for the notion that monetary policy should not have important effects on output. The work of Nelson and Plosser cast doubt on the empirical importance of aggregate demand shocks. These ideas supported the development of
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- Summer '18
- Sagar Arora