Deconstructing the Success of Real Business Cycles

By Nakamura, Emi | Economic Inquiry, October 2009 | Go to article overview

Deconstructing the Success of Real Business Cycles


Nakamura, Emi, Economic Inquiry


I. INTRODUCTION

A major achievement of Real Business Cycle (RBC) models has been their success at elegantly explaining a remarkably large fraction of business cycle fluctuations in aggregate variables based solely on exogenous variation in productivity. In particular, the RBC literature has emphasized the ability of models driven by productivity shocks to explain the historically observed paths of macroeconomic variables, a method introduced by Plosser (1989). In a recent paper in the Handbook of Macroeconomics, King and Rebelo (1999) remark on the "dramatic" correspondence between simulations of the US economy produced by the RBC model and the actual data when productivity shocks are "remeasured" and the bare-bones model is augmented with the assumptions of indivisible labor and variable capital utilization. RBC models explain the comovement of a multiplicity of macroeconomic variables consumption, output, labor supply, investment, wages, productivity, etc.--with a single exogenous shock series. In other words, they reduce a more than five-dimensional problem to one dimension of unexplained variation.

The contribution of the RBC methodology to the business cycle literature can be thought of in two parts. First, RBC models adopt a basic dynamic stochastic general equilibrium framework that has now become standard in the macroeconomics business cycle literature, including New Keynesian models. Second, the RBC literature emphasizes the importance of the productivity shock. This paper investigates the question of how much of the success of RBC, according to standard RBC evaluation techniques, arises from the basic form of the dynamic stochastic general equilibrium model versus the specific role of the productivity shock. The answer to this question says something both about the nature of the dynamic stochastic general equilibrium models used in macroeconomics as well as about the standard RBC tests used to evaluate these models.

The models considered in this paper all have the basic form of the "high-substitution" RBC model developed by King and Rebelo (1999). I consider both the original form of this model, as well as a "Monetary Business Cycle" (MBC) version of the model augmented with a Calvo Phillips curve and a standard Taylor rule specification of monetary policy. I adopt the procedure of "remeasuring" the business cycle shocks to perfectly match the observed output series by King and Rebelo (1999). I consider the models' success at explaining the behavior of macroeconomic variables given a variety of specifications of shocks: productivity shocks, monetary shocks to the Taylor rule, cost-push shocks, and preference shocks. This exercise shows that any of the models with "remeasured" shocks is able to successfully explain the empirical dynamics of the real variables. The monetary model with remeasured shocks is, if anything, more empirically successful than the RBC model, since it is also able to explain the behavior of inflation and the nominal interest rate in the Volcker-Greenspan era. Thus, this paper adds concreteness to work by Hansen and Heckman (1996) and Fair (1992), suggesting that the RBC standards for evaluating models may be too weak by showing that important classes of business cycle models cannot be distinguished using standard RBC evaluation techniques.

The MBC models considered in this paper have the same basic structure as the model presented in Rotemberg and Woodford (1997). The most closely related paper to the present work is perhaps the innovative paper by Hairault and Portier (1993), which evaluates the performance of a MBC model when presented with various combinations of estimated monetary and productivity shocks. Unlike the present paper, however, the success of the models is evaluated according to their second moment properties.

The paper proceeds as follows. Section II presents the model, which consists of a household sector, a firm sector and a central bank. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Deconstructing the Success of Real Business Cycles
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.