Real Business Cycles: A Reader

By James E. Hartley; Kevin D. Hoover et al. | Go to book overview

CHAPTER 6

Federal Reserve Bank of Minneapolis

Quarterly Review Fall 1986

Response to a Skeptic

Edward C. Prescott

Adviser

Research Department

Federal Reserve Bank of Minneapolis and Professor of Economics

University of Minnesota

New findings in science are always subject to skepticism and challenge. This is an important part of the scientific process. Only if new results successfully withstand the attacks do they become part of accepted scientific wisdom. Summers (in this issue) is within this tradition when he attacks the finding I describe (in this issue) that business cycles are precisely what economic theory predicts given the best measures of people’s willingness and ability to substitute consumption and leisure, both between and within time periods. I welcome this opportunity to respond to Summers’ challenges to the parameter values and the business cycle facts that I and other real business cycle analysts have used. In challenging the existing quality of measurement and not providing measurement inconsistent with existing theory, Summers has conceded the point that theory is ahead of business cycle measurement.


Miscellaneous Misfires

Before responding to Summers’ challenges to the measurements used in real business cycle analyses, I will respond briefly to his other attacks and, in the process, try to clarify some methodological issues in business cycle theory as well as in aggregate economic theory more generally.


Prices

Summers asks, Where are the prices? This question is puzzling. The mechanism real business cycle analysts use is the one he and other leading people in the field of aggregate public finance use: competitive equilibrium. Competitive equilibria have relative prices. As stated in the introduction of “Theory Ahead of Business Cycle Measurement” (in this issue), the business cycle puzzle is, Why are there large movements in the time allocated to market activities and little associated movements in the real wage, the price of people’s time? Along with that price, Kydland and I (1982, 1984) examine the rental price of capital. An infinity of other relative prices can be studied, but these are the ones needed to construct national income and product accounts. The behavior of these prices in our models conforms with that observed.

In competitive theory, an economic environment is needed. For that, real business cycle analysts have used the neoclassical growth model. It is the preeminent model in aggregate economics. It was developed to account for the growth facts and has been widely used for predicting the aggregate effects of alternative tax schemes as well. With the labor/leisure decision endogenized, it is the appropriate model to study the aggregate implications of technology change uncertainty. Indeed, in 1977 Lucas, the person responsible for making business cycles again a central focus in economics, defined them (p. 23) as deviations from the neoclassical growth model—that is, fluctuations in hours allocated to market activity that are too large to be accounted for by changing marginal productivities of labor as reflected in real wages. Lucas, like me and

28

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Real Business Cycles: A Reader
Table of contents

Table of contents

  • Title Page iii
  • Contents vii
  • Acknowledgements xi
  • Part I - Introduction 1
  • Chapter 1 - The Limits of Business Cycle Research 3
  • Notes 34
  • Chapter 2 - A User's Guide to Solving Real Business Cycle Models 43
  • Part II - The Foundations of Real Business Cycle Modeling 55
  • Chapter 3 57
  • Chapter 4 83
  • References 96
  • Chapter 5 97
  • Chapter 6 102
  • Chapter 7 108
  • Part III - Some Extensions 147
  • Chapter 8 149
  • Chapter 9 168
  • References 178
  • Chapter 10 - Current Real-Business-Cycle Theories and Aggregate Labor-Market Fluctuations 179
  • Chapter 11 - The Inflation Tax in a Real Business Cycle Model 200
  • Part IV - The Methodology of Equilibrium Business Cycle Models 217
  • Chapter 12 219
  • Chapter 13 237
  • Chapter 14 254
  • Chapter 15 272
  • Part V - The Critique of Calibration Methods 293
  • Chapter 16 295
  • Chapter 17 - Measures of Fit for Calibrated Models 302
  • Chapter 18 333
  • Chapter 19 355
  • Part VI - Testing the Real Business Cycle Model 381
  • Chapter 20 - Business Cycles: Real Facts and a Monetary Myth 383
  • References 398
  • Chapter 21 399
  • Chapter 22 - Evaluating a Real Business Cycle Model 431
  • Chapter 23 462
  • Chapter 24 496
  • Chapter 25 513
  • Chapter 26 - Did Technology Shocks Cause the 1990-1991 Recession? 533
  • Part VII - The Solow Residual 541
  • Chapter 27 - Technical Change and the Aggregate Production Function 543
  • Chapter 28 552
  • Chapter 29 564
  • Chapter 30 - Output Dynamics in Real-Business-Cycle Models 571
  • Part VIII - Filtering and Detrending 591
  • Chapter 31 - Postwar U. S. Business Cycles: an Empirical Investigation 593
  • Chapter 32 609
  • Chapter 33 626
  • Index 652
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