Journal of Monetary Economics 21 (1988) 195-232. North-Holland
PRODUCTION, GROWTH AND BUSINESS CYCLES
I. The Basic Neoclassical Model
Robert G. KING, Charles I. PLOSSER and Sergio T. REBELO *
University of Rochester, Rochester, NY 14627, USA
Received September 1987, final version received December 1987 This paper presents the neoclassical model of capital accumulation augmented by choice of labor supply as the basic framework of modern real business cycle analysis. Preferences and production possibilities are restricted so that the economy displays steady state growth. Then we explore the implications of the basic model for perfect foresight capital accumulation and for economic fluctuations initiated by impulses to technology. We argue that the neoclassical approach holds considerable promise for enhancing our understanding of fluctuations. Nevertheless, the basic model does have some important shortcomings. In particular, substantial persistence in technology shocks is required if the model economy is to exhibit periods of economic activity that persistently deviate from a deterministic trend.
Real business cycle analysis investigates the role of neoclassical factors in shaping the character of economic fluctuations. In this pair of essays, we provide an introduction to the real business cycle research program by considering the basic concepts, analytical methods and open questions on the frontier of research. The focus of the present essay is on the dynamic aspects of the basic neoclassical model of capital accumulation. This model is most frequently encountered in analyses of economic growth, but we share Hicks’ (1965, p. 4) perspective that it is also a basic laboratory for investigating more general dynamic phenomena involving the choice of consumption, work effort and investment.
Our use of the neoclassical model of capital accumulation as the engine of analysis for the investigation of economic fluctuations raises a number of central issues. First, what role does economic growth play in the study of
*The authors acknowledge financial support from the National Science Foundation. King and Plosser have joint affiliations with the Department of Economics and the W. E. Simon Graduate School of Business, University of Rochester. Rebelo is affiliated with the Department of Economics, University of Rochester and the Department of Economics, Portuguese Catholic University. We have benefited from the comments of Andrew Abel and Larry Christiano, as well as from those of seminar participants at the Federal Reserve Bank of Richmond, Brasenose College, Oxford, Institute for International Economic Studies, University of Stockholm, Northwestern University, Yale University, and Columbia University.
0304-3932/88/$3.50 ©1988, Elsevier Science Publishers B. V. (North-Holland)