Class 12 Real Business Cycles
Wed 8 October
Prerequisites
Jones chapter 15.2
The textbook has little to say about this topic, largely because the 1980s RBC approach has dated as badly as that decade’s hairstyles. However, there are good reasons to give this canonical neoclassical model more showtime…
- RBC builds a bridge between theories of long-run growth (Solow) and short-term cycles (Frisch-Slutsky)
- RBC supercharges the Solow model with microfoundations, enabling utility-maximising choices of savings and labour supply
- RBC is the forerunner of modern DSGE models that we study in future classes
- RBC recognises the importance of expectations in framing current spending decisions
- RBC credits the private sector with smart (arguably too smart!) insights, meaning that policymakers have to work much harder to make a macro difference
As Jones makes clear, the key to understanding RBC analysis is recognising that temporary, yet persistent, shocks in TFP can generate cycles. Moroever, TFP is not just about technology and innovative ideas; it also reflects institutions, taxes and random stuff such as pandemics, geo-political upsets and supply disruptions. In other words, TFP shocks can be negative as well as positive.
Impulse response functions, a key macro visualisation technique that was introduced in Class 2 (the multiplier-accelerator model), make a reappearance.
Class Topics & Activities
- RBC & Solow models compared
- Modelling expectations
- Macro policy & rational expectations
- IRFs redux
- Assessing the RBC approach
Follow Up References