# The RBC methodology also comes down to two principles:

Save this PDF as:

Size: px
Start display at page:

## Transcription

1 Chapter 5 Real business cycles 5.1 Real business cycles The most well known paper in the Real Business Cycles (RBC) literature is Kydland and Prescott (1982). That paper introduces both a specific theory of business cycles, and a methodology for testing competing theories of business cycles. The RBC theory of business cycles has two principles: 1. Money is of little importance in business cycles. 2. Business cycles are created by rational agents responding optimally to real (not nominal) shocks - mostly fluctuations in productivity growth, but also fluctuations in government purchases, import prices, or preferences. The RBC methodology also comes down to two principles: 1. The economy should always be modeled using dynamic general equilibrium models (with rational expectations). 2. The quantitative implications of a proposed model should be taken seriously. In particular, a model s suitability for describing reality should be evaluated using a quantitative technique known as calibration. If the model fits the data, its quantitative policy implications should be taken seriously. 1

2 2 CHAPTER 5. REAL BUSINESS CYCLES Romer, writing just a few years ago, treats these two meanings of the term as essentially the same. But since then, the RBC methodology has taken hold in a lot of places - researchers have analyzed RBC models with money, with all sorts of market imperfections, etc. In order to reflect this change, researchers are trying to change the name of the methodology to the more accurate (if awkward) stochastic dynamic general equilibrium macroeconomics Some facts about business cycles Business cycles are the reason why macroeconomics exists as a field of study, and they re the primary consideration of many macroeconomists. What characterizes business cycles? The two obvious characteristics are fluctuations in unemployment and output. A few definitions: Procyclical: a variable that usually increases in booms, decreases in recessions. For example, productivity is procyclical. Countercyclical: a variable that usually decreases in booms, increases in recessions. For example, unemployment is countercyclical. Acyclical: a variable that shows no systematic relationship to the business cycle. Fiscal policy: the government s policy for taxes and spending. Monetary policy: the government s policy for how much money to put into the economy. Before we go into the details of an RBC model, let s establish some stylized facts about business cycles. Most of these are outlined in the beginning of Chapter 4 in Romer. 1. Labor input varies considerably and procyclically (goes up in booms, down in recessions). Most of this variation is variation in employment rates, though some is in average weekly hours. 2. The capital stock varies little at business cycle frequencies (1-3 years).

3 5.1. REAL BUSINESS CYCLES 3 3. Productivity growth (as measured by the Solow residual) is procyclical, though not nearly as much as labor input. In other words, most of the output loss in recessions can be traced to unemployment. 4. Wages vary less than productivity, and have low correlation with output. 5. All major expenditure categories are procyclical. Investment in consumer and producer durables is quite volatile, while consumption of nondurables and services varies much less than output. The most volatile expenditure category is inventory investment. One of the main research programs in macro has been to explain these facts in a consistent manner (using a well-specified equilibrium model). A few major puzzles: Why do labor inputs vary? Specifically, if there is cyclical unemployment, what shock causes labor demand to go down? Once labor demand goes down, why is this reflected in unemployment rather than wage cuts? Decreasing returns to scale in labor implies countercyclical productivity, but productivity is procyclical. Why? Why are recessions so persistent? Returning to what we said earlier, one of the key puzzles in business cycle theory is procyclical productivity. The RBC theory explains procyclical productivity quite directly - booms are good draws of technology growth recessions are bad draws. The second puzzle is employment. In the baseline RBC model, employment fluctuations are just intertemporal substitution of leisure. In some time periods, labor is less productive than others. The optimal action for workers is to work more in productive periods, less in unproductive periods. This explains unemployment. The third puzzle is persistence. In the baseline RBC mode, capital accumulatioon is the internal propagation mechanism - the thing that converts shocks without persistence into highly persistent shocks to output. If the

4 4 CHAPTER 5. REAL BUSINESS CYCLES technology level is below average, output is low, so investment is low, so the next period s capital stock is also below average. So even if the technology level returns to normal next period, output will be below normal. A fourth observation (not so much a puzzle) is why investment spending is more variable than consumption spending. This is not so hard to explain in the baseline RBC model (or any other model): an agent with the preference to smooth consumption over time will invest in productive periods and eat capital in unproductive periods The model Now let s put this into a model. We ll take the equilibrium growth model that we ve already looked at, and add a labor-leisure choice, and a stochastic technology. This produces what s commonly known as the baseline real business cycle model. The version of the model I m outlining here is from Chapter 1 in Thomas Cooley s Frontiers of Business Cycle Research. The chapter is written by Cooley and Prescott. The model described in Romer is basically the same. Consumers The consumer s problem is the same as before, except that he values leisure. He supplies labor h t [0, 1] in period t, just like before, but now he receives utility from leisure. The consumer also has uncertainty over future prices, so he maximizes expected utility: subject to the constraints: E 0 β t u(c t, 1 h t ) (5.1) t=0 x t + c t + b t+1 w t h t + r t k t + R t b t + π t k t+1 (1 δ)k t + x t k t 0 k 0 NP G given

5 5.1. REAL BUSINESS CYCLES 5 We assume that the consumer is making all time-t choices (x t, c t, k t+1, b t+1, h t ) conditional on time t information (all variables subscripted t and below, plus the interest rate on bonds R t+1 ). Notice that we will be modeling fluctuations in employment as a representative consumer varying his hours. Of course, employment fluctuations are a lot lumpier than that - this may affect the outcomes we look at. The firm We ve talked about the consumer dealing with stochastic prices. We haven t discussed the source of uncertainty. That will be on the firm side. The firm is the same as before. However, the production function is subject to random productivity shocks: The firm s problem is: max e zt F (K t, H t ) w t H t r t K t (5.2) K t,h t where F is a neoclassical production function and z t follows an AR(1) process: where ɛ t is white noise. z t = ρz t 1 + ɛ t (5.3) Equilibrium When variables are stochastic, equilibrium is defined slightly differently. An equilibrium in this economy is a joint distribution of prices and allocations such that, etc Solving the model The consumer s Lagrangian is: E 0 β t u(c t, 1 h t ) + λ t ((1 δ)k t + w t h t + r t k t + π t c t k t+1 ) (5.4) t=0

6 6 CHAPTER 5. REAL BUSINESS CYCLES The first order conditions are: c t : E t (β t u c (c t, 1 h t ) λ t ) = 0 (5.5) h t : E t ( β t u l (c t, 1 h t ) + λ t w t ) = 0 (5.6) k t+1 : E t (λ t+1 (1 δ + r t+1 ) λ t ) = 0 (5.7) b t+1 : E t (λ t+1 (R t+1 ) λ t ) = 0 (5.8) plus the capital accumulation equation and the transversality condition. The appropriate expectations operator is E t because each of these variables is chosen with the information available at time t. We can eliminate the expectations operator if the variables inside it are in the time t information set. So we have: λ t = β t u c (c t, h t ) (5.9) as in the basic equilibrium growth model, and: u l (c t, 1 h t ) = u c (c t, 1 h t )w t (5.10) This equation shows that the worker equates the marginal utility from a little more leisure to the utility from working an equal amount and getting more consumption. In addition, we have: u c (c t, 1 h t ) = βe t [u c (c t+1, 1 h t+1 )(r t δ)] (5.11) which is just the same as Euler equation for the basic growth model, but with the expectations operator. 1 Finally, the bond price is given by: The solution to the firm s problem implies: R t+1 = E t (r t+1 ) + 1 δ (5.13) w t = e zt F H (K t, H t ) (5.14) r t = e zt F K (K t, H t ) (5.15) 1 Remember that So we can rewrite () as: E(XY ) = Cov(X, Y ) + E(X)E(Y ) u c (c t, h t ) = β[e t (u c (c t+1, h t+1 ))(E t (r t+1 ) + 1 δ) + Cov t (u c (c t+1, h t+1 ), r t+1 )] (5.12) We see that today s decision doesn t just depend on the expected value of future prices but also their covariance with consumption.

7 5.1. REAL BUSINESS CYCLES Calibration Kydland and Prescott suggest a way to identify if this model can explain business cycles. Their method is known as calibration. The procedure is: Use microeconomic studies or theory to find values for all of the parameters. Solve the model numerically, and simulate the economy. Compare the moments (standard deviations, correlations, etc) of the simulated economy with those in the actual economy. If the moments are matched, success! If not, the moments which don t match up suggest areas of potential model improvement. We re going to do this with the model. First, we need to put parametric functional forms. First, utility: u(c, 1 h) = ( c 1 α t (1 h t ) α) 1 χ 1 χ (5.16) This is a variation on the CRRA form we ve been using. Note that 1/χ is the intertemporal elasticity of substitution. When χ = 0, utility is linear, when χ =, utility is Leontief, and when χ = 1, utility is Cobb-Douglas (logarithmic). Production is assumed to be Cobb-Douglas: F (K, H) = K θ H 1 θ (5.17) Now, we need plausible parameter values for this model. I ll use the values from Cooley and Prescott (1995). Their model is identical to the one here, except that they allow for population growth at rate ν and productivity growth at a rate γ. First, β. At the non-stochastic steady state, we have R = 1 β. The average real interest rate in the U.S. is usually around 4% annually, which is about

8 8 CHAPTER 5. REAL BUSINESS CYCLES 1% quarterly. So R 1 = 1 1 = 0.01, or β Cooley and Prescott β follow a slightly more complex process and calibrate β as Next, θ. If you remember, 1 θ will be labour s share of output, a quantity that can be estimated from the national income accounts. Cooley and Prescott set θ to χ is set to one. Estimates from micro studies of the typical worker s intertemporal elasticity of substitution are in this range, and χ = 1 gives us a simple Cobb-Douglas form of the utility function u(c, h) = (1 α) ln c + α ln(1 h) (5.18) Now, solving for the steady state relationship between consumption, labour supply, and output, we get the following: α 1 h = 1 α w c (5.19) = 1 α (1 θ) y c h (5.20) α is set so that, in the non-stochastic steady state, 31% of available time is spent working (h = 0.31)and the steady state output to consumption ratio is about 1.33 (c/y = 1.33). Substituting into the equations above and solving for α, we get α = Cooley and Prescott estimate that depreciation is 4.8% annually, so 1.2% quarterly (δ = 0.012). The parameters of the stochastic process for technology is easy to estimate. This model has perfect competition and constant returns to scale. So z t z t 1 is the Solow residual. The average value of the Solow residual gives us our estimate for γ. Cooley and Prescott set γ = , giving about 1.6% annual TFP growth. Once we subtract out this average, we can estimate an AR(1) model and get ρ = 0.95 and σ ɛ = Finally the quarterly population growth rate ν is set at Numerical solution of the model Once we have set up the model, and calibrated parameters, we next need to find a numerical solution to the model.

9 5.1. REAL BUSINESS CYCLES 9 Demonstrate that the equilibrium of the model correspond to some planner s problem, that the solution to the planner s problem corresponds to some Bellman s equation, and apply numerical dynamic programming methods. Transform the problem itself using a linear-quadratic approximation around the steady state. Basically, you take a quadratic approximation of the objective function and a linear approximation of the constraints. The result will be a model with linear Euler equations. Log-linearization of the Euler equations around the steady state. This has the advantage that it leads to closed-form approximate results, so we can in the words of one researcher inspect the mechanism. As with all linear approximations, this is a good approximation near the steady state but may be a poor approximation to how the system responds to large shocks. Simulation Under those assumptions we can simulate the model on a computer and we get time series for output, employment, productivity, investment, consumption, and capital. We can look at the correlation between any of these variables, the relative variance of different variables, etc. There are many ways to do this simulation. The easiest is to take the Euler equations, take logs of everything, and linearize them around the balanced growth path. So the resulting variables are detrended - defined in terms of percentage deviation from trend/bgp. Once you have these simulated variables, you compare their properties to the properties of the corresponding detrended variables from the economy in question. US data Baseline RBC model Std. Dev (%) ρ x,gnp Std. Dev (%) ρ x,gnp GNP Consumption (NDS) Investment (GPDI) Hours Productivity

10 10 CHAPTER 5. REAL BUSINESS CYCLES As you can see, the variability in output is a little smaller, but the same order of magnitude. As in reality, consumption is much less variable than output and investment is much more variable. Just like in real life, the model s variables are closely correlated with output. They re actually a little too closely correlated, which Cooley and Prescott note is due to the fact that there s only one source of uncertainty in this model. To an RBC theorist, these numbers represent success. We ve managed to write down a very simple model that duplicates many of the properties (moments) of the actual data. There are a few failures though. This model seems to understate the variability of both consumption and hours. The RBC approach to this failing is to investigate why the model doesn t match, and adjust the model so that it does match. The consumption variability is simple. Even with careful measurement, a lot of consumption is actually purchase of consumer durables, which really belongs in investment Other issues Variation in labor For an example of how the dynamic GE approach is supposed to work, let s consider the low variation in hours. Gary Hansen, in a 1985 paper, developed an explanation and a fix. All of the variation in hours worked in this model take the form of changes in the hours worked by each worker. We know that most of the variation in hours over the business cycle take the form of variations in employment. Recall that the functional form of utility is: u(c, h) = ( c 1 α t (1 h t ) α) 1 χ 1 1 χ (5.21) In order to generate higher variation in hours worked for each individual worker, we need to make them more willing to substitute intertemporally - work less when wages are low and more when they are high. For example, if χ = 0, then their IES is infinity - they will work all day or not at all, depending on wages. But micro studies show a low IES, so we can t justify simply lowiering χ.

11 5.1. REAL BUSINESS CYCLES 11 Hansen s solution is to note that much of the variation in hours takes the form of variation in employment itself. He argues that it is not profitable to vary hours, given the fixed costs of employment. Instead he sets up the following model of the labor market. At the beginning of each period, a worker signs a binding contract to work h (say 8) hours with probability π t and zero hours with probability (1π t ). Whether the worker works or not is decided by lottery. The worker gets paid wage w t π t whether or not he works. He doesn t get to choose the value of h, but does choose π t. Expected utility is: E[1 α ln c + α ln(1 h)] = (1 α) ln c + πα ln(1 h ) (5.22) Now notice that this is linear in π t. Per capita hours in this economy are π t h, so the aggregate IES is quite high. It turns out that once you make this change, hours are much more variable, and the problem is fixed. Internal propagation mechanism One of the most difficult problems for RBC adherents to deal comes from the results of Cogley and Nason (AER 1995). They analyze the baseline RBC model from a different perspective. One of the selling points of the RBC model is that fluctuations in the model are persistent. However, their persistence really isn t much more than that of the Solow residual, which is the exogenous source of shocks. Remember that the source of persistence in the baseline RBC model is that investment is higher in booms, so capital is higher in the near future. The problem is that new investment is very small relative to the capital stock, so the capital stock itself varies little. Many papers since Cogley and Nason aim to find a better internal persistence mechanism. These include: Financial markets - for example suppose that an unexpected negative shock causes solvent but illiquid companies to become cashflowconstrained or even go bankrupt. They could then become less efficient as a result. Labor market search - suppose that it takes time for workers to find new jobs that they match well with.

12 12 CHAPTER 5. REAL BUSINESS CYCLES Notice that these solutions tend to move the models away from the world of perfectly functioning markets and no motivation for intervention Criticisms The RBC school of thought has grown substantially since the early papers. Part of the reason is that it s compelling as science. We take the model seriously, expect it to actually match observations quantitatively, and when it doesn t, we adjust the model. Another reason it s done so well is that the methodology is a natural article generator. Find something that hasn t been modeled yet, add it to the baseline model, and see what you get. The schools that focus in this area have turned out vast quantities of grad students over the last few years. The main criticisms of the dynamic GE methodology are: Why would you consider matching the moments in the data a desirable property in a model that you know leaves out important features? Statistical tests are meaningless except in the context of an alternative. It may be the case that there are hundreds of different models that do equally well. Some key criticisms of the specific hypothesis that fluctuations in technical progress explain business cycles are: If we are to identify the Solow residual as the measure of short-term technological progress, we must be prepared to interpret many deep recessions as exhibiting technical regress (especially the Great Depression or the recent troubles in Japan). Furthermore it is not clear what particular technological advances or disasters can be associated with any of the major short-term swings in the Solow residual. If the Solow residual measures what RBC model says it does, then it should be uncorrelated with the political party of the President, millitary purchases, and oil price movements (once energy usage has been accounted for). But it is correlated with all those things (Hall)

13 5.1. REAL BUSINESS CYCLES 13 One approach that some proponents of the RBC theory have suggested is that the Solow residual is poorly measured. Capital (and labor) utilization rates tend to vary significantly and procyclically. If you use the capital stock to measure the flow of capital services, you will overstate the extent of fluctuations in technical progress. There s a paper by King and Rebelo in the Handbook of Macroeconomics that adds variable utilization to an RBC model and gets plausible fluctuations without negative Solow residuals.

Real Business Cycle Models Lecture 2 Nicola Viegi April 2015 Basic RBC Model Claim: Stochastic General Equlibrium Model Is Enough to Explain The Business cycle Behaviour of the Economy Money is of little

### VI. Real Business Cycles Models

VI. Real Business Cycles Models Introduction Business cycle research studies the causes and consequences of the recurrent expansions and contractions in aggregate economic activity that occur in most industrialized

### Lecture 14 More on Real Business Cycles. Noah Williams

Lecture 14 More on Real Business Cycles Noah Williams University of Wisconsin - Madison Economics 312 Optimality Conditions Euler equation under uncertainty: u C (C t, 1 N t) = βe t [u C (C t+1, 1 N t+1)

### 2. Real Business Cycle Theory (June 25, 2013)

Prof. Dr. Thomas Steger Advanced Macroeconomics II Lecture SS 13 2. Real Business Cycle Theory (June 25, 2013) Introduction Simplistic RBC Model Simple stochastic growth model Baseline RBC model Introduction

### Intermediate Macroeconomics: The Real Business Cycle Model

Intermediate Macroeconomics: The Real Business Cycle Model Eric Sims University of Notre Dame Fall 2012 1 Introduction Having developed an operational model of the economy, we want to ask ourselves the

### A Review of the Literature of Real Business Cycle theory. By Student E XXXXXXX

A Review of the Literature of Real Business Cycle theory By Student E XXXXXXX Abstract: The following paper reviews five articles concerning Real Business Cycle theory. First, the review compares the various

### Real Business Cycles. Federal Reserve Bank of Minneapolis Research Department Staff Report 370. February 2006. Ellen R. McGrattan

Federal Reserve Bank of Minneapolis Research Department Staff Report 370 February 2006 Real Business Cycles Ellen R. McGrattan Federal Reserve Bank of Minneapolis and University of Minnesota Abstract:

Real Business Cycle Theory Guido Ascari University of Pavia () Real Business Cycle Theory 1 / 50 Outline Introduction: Lucas methodological proposal The application to the analysis of business cycle uctuations:

### REAL BUSINESS CYCLE THEORY METHODOLOGY AND TOOLS

Jakub Gazda 42 Jakub Gazda, Real Business Cycle Theory Methodology and Tools, Economics & Sociology, Vol. 3, No 1, 2010, pp. 42-48. Jakub Gazda Department of Microeconomics Poznan University of Economics

### The Real Business Cycle model

The Real Business Cycle model Spring 2013 1 Historical introduction Modern business cycle theory really got started with Great Depression Keynes: The General Theory of Employment, Interest and Money Keynesian

Chapter 4 Real Business Cycle Theory This section of the textbook focuses on explaining the behavior of the business cycle. The terms business cycle, short-run macroeconomics, and economic fluctuations

MA Advanced Macroeconomics: 7. The Real Business Cycle Model Karl Whelan School of Economics, UCD Spring 2015 Karl Whelan (UCD) Real Business Cycles Spring 2015 1 / 38 Working Through A DSGE Model We have

### 3 The Standard Real Business Cycle (RBC) Model. Optimal growth model + Labor decisions

Franck Portier TSE Macro II 29-21 Chapter 3 Real Business Cycles 36 3 The Standard Real Business Cycle (RBC) Model Perfectly competitive economy Optimal growth model + Labor decisions 2 types of agents

Phd Macro, 2007 (Karl Whelan) 1 Real Business Cycle Models The Real Business Cycle (RBC) model introduced in a famous 1982 paper by Finn Kydland and Edward Prescott is the original DSGE model. 1 The early

### The Real Business Cycle Model

The Real Business Cycle Model Ester Faia Goethe University Frankfurt Nov 2015 Ester Faia (Goethe University Frankfurt) RBC Nov 2015 1 / 27 Introduction The RBC model explains the co-movements in the uctuations

### ECON20310 LECTURE SYNOPSIS REAL BUSINESS CYCLE

ECON20310 LECTURE SYNOPSIS REAL BUSINESS CYCLE YUAN TIAN This synopsis is designed merely for keep a record of the materials covered in lectures. Please refer to your own lecture notes for all proofs.

Why Does Consumption Lead the Business Cycle? Yi Wen Department of Economics Cornell University, Ithaca, N.Y. yw57@cornell.edu Abstract Consumption in the US leads output at the business cycle frequency.

Advanced Macroeconomics (2) Real-Business-Cycle Theory Alessio Moneta Institute of Economics Scuola Superiore Sant Anna, Pisa amoneta@sssup.it March-April 2015 LM in Economics Scuola Superiore Sant Anna

### UNIVERSITY OF OSLO DEPARTMENT OF ECONOMICS

UNIVERSITY OF OSLO DEPARTMENT OF ECONOMICS Exam: ECON4310 Intertemporal macroeconomics Date of exam: Thursday, November 27, 2008 Grades are given: December 19, 2008 Time for exam: 09:00 a.m. 12:00 noon

### Real Business Cycle Theory-A Systematic Review

MPRA Munich Personal RePEc Archive Real Business Cycle Theory-A Systematic Review Binbin Deng Department of Economics, Hong Kong University of Science and Technology 27. July 2009 Online at http://mpra.ub.uni-muenchen.de/17932/

### Fundamental Economic Factors

Classical Model Real business cycle theory seeks to explain business cycles via the classical model. There is general equilibrium: demand equals supply in every market. An ideological conviction underlies

### Summing up ECON4310 Lecture. Asbjørn Rødseth. University of Oslo 27/

Summing up 4310 ECON4310 Lecture Asbjørn Rødseth University of Oslo 27/11 2013 Asbjørn Rødseth (University of Oslo) Summing up 4310 27/11 2013 1 / 20 Agenda Solow, Ramsey and Diamond Real Business Cycle

Chapter 4 Cash in advance model 4.1 Motivation In this lecture we will look at ways of introducing money into a neoclassical model and how these methods can be developed in an effort to try and explain

### Learning objectives. The Theory of Real Business Cycles

Learning objectives This chapter presents an overview of recent work in two areas: Real Business Cycle theory New Keynesian economics Advances in Business Cycle Theory slide 1 The Theory of Real Business

### Current Accounts in Open Economies Obstfeld and Rogoff, Chapter 2

Current Accounts in Open Economies Obstfeld and Rogoff, Chapter 2 1 Consumption with many periods 1.1 Finite horizon of T Optimization problem maximize U t = u (c t ) + β (c t+1 ) + β 2 u (c t+2 ) +...

Graduate Macroeconomics 2 Lecture 1 - Introduction to Real Business Cycles Zsófia L. Bárány Sciences Po 2014 January About the course I. 2-hour lecture every week, Tuesdays from 10:15-12:15 2 big topics

Graduate Macro Theory II: The Real Business Cycle Model Eric Sims University of Notre Dame Spring 2011 1 Introduction This note describes the canonical real business cycle model. A couple of classic references

### Chapter 11. Market-Clearing Models of the Business Cycle

Chapter 11 Market-Clearing Models of the Business Cycle Goal of This Chapter In this chapter, we study three models of business cycle, which were each developed as explicit equilibrium (market-clearing)

### The Real Business Cycle School

Major Currents in Contemporary Economics The Real Business Cycle School Mariusz Próchniak Department of Economics II Warsaw School of Economics 1 Background During 1972-82,the dominant new classical theory

### Final. 1. (2 pts) What is the expected effect on the real demand for money of an increase in the nominal interest rate? How to explain this effect?

Name: Number: Nova School of Business and Economics Macroeconomics, 1103-1st Semester 2013-2014 Prof. André C. Silva TAs: João Vaz, Paulo Fagandini, and Pedro Freitas Final Maximum points: 20. Time: 2h.

### Money and Public Finance

Money and Public Finance By Mr. Letlet August 1 In this anxious market environment, people lose their rationality with some even spreading false information to create trading opportunities. The tales about

### 1 National Income and Product Accounts

Espen Henriksen econ249 UCSB 1 National Income and Product Accounts 11 Gross Domestic Product (GDP) Can be measured in three different but equivalent ways: 1 Production Approach 2 Expenditure Approach

### Conditional guidance as a response to supply uncertainty

1 Conditional guidance as a response to supply uncertainty Appendix to the speech given by Ben Broadbent, External Member of the Monetary Policy Committee, Bank of England At the London Business School,

### Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence

Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence Zeldes, QJE 1989 Background (Not in Paper) Income Uncertainty dates back to even earlier years, with the seminal work of

### A Model of Financial Crises

A Model of Financial Crises Coordination Failure due to Bad Assets Keiichiro Kobayashi Research Institute of Economy, Trade and Industry (RIETI) Canon Institute for Global Studies (CIGS) Septempber 16,

### The real business cycle theory

Chapter 29 The real business cycle theory Since the middle of the 1970s two quite different approaches to the explanation of business cycle fluctuations have been pursued. We may broadly classify them

### Teaching modern general equilibrium macroeconomics to undergraduates: using the same t. advanced research. Gillman (Cardi Business School)

Teaching modern general equilibrium macroeconomics to undergraduates: using the same theory required for advanced research Max Gillman Cardi Business School pments in Economics Education (DEE) Conference

### New Keynesian Economics: Sticky Prices Copyright 2014 Pearson Education, Inc.

Chapter 14 New Keynesian Economics: Sticky Prices Copyright Chapter 14 Topics Construction of the New Keynesian Sticky Price Model extending the Monetary Intertemporal Model. The Role of Government Policy

### Real Business Cycle Theory. Marco Di Pietro Advanced () Monetary Economics and Policy 1 / 35

Real Business Cycle Theory Marco Di Pietro Advanced () Monetary Economics and Policy 1 / 35 Introduction to DSGE models Dynamic Stochastic General Equilibrium (DSGE) models have become the main tool for

### Further Discussion of Temporary Payroll Tax Cut During Recession(s) Mark Bils and Pete Klenow, December 12, 2008

Further Discussion of Temporary Payroll Tax Cut During Recession(s) Mark Bils and Pete Klenow, December 12, 2008 We focus on three aspects of a cut in payroll taxes as a stabilizer in a recession: (1)

### GENERAL EQUILIBRIUM WITH BANKS AND THE FACTOR-INTENSITY CONDITION

GENERAL EQUILIBRIUM WITH BANKS AND THE FACTOR-INTENSITY CONDITION Emanuel R. Leão Pedro R. Leão Junho 2008 WP nº 2008/63 DOCUMENTO DE TRABALHO WORKING PAPER General Equilibrium with Banks and the Factor-Intensity

### Chapter 13 Real Business Cycle Theory

Chapter 13 Real Business Cycle Theory Real Business Cycle (RBC) Theory is the other dominant strand of thought in modern macroeconomics. For the most part, RBC theory has held much less sway amongst policy-makers

### Lecture 2 Dynamic Equilibrium Models : Finite Periods

Lecture 2 Dynamic Equilibrium Models : Finite Periods 1. Introduction In macroeconomics, we study the behavior of economy-wide aggregates e.g. GDP, savings, investment, employment and so on - and their

### Ifo Institute for Economic Research at the University of Munich. 6. The New Keynesian Model

6. The New Keynesian Model 1 6.1 The Baseline Model 2 Basic Concepts of the New Keynesian Model Markets are imperfect: Price and wage adjustments: contract duration, adjustment costs, imperfect expectations

### A Progress Report on Business Cycle Models

Federal Reserve Bank of Minneapolis Quarterly Review Vol. 18, No. 4, Fall 1994 A Progress Report on Business Cycle Models Ellen R. McGrattan* Economist Research Department Federal Reserve Bank of Minneapolis

### THE 1970S saw a distinctive shift in

Journal of Economics Literatute Vol. XXXII (December 1994), pp. 1750 1783 Real Business Cycles Stadler: Real Business Cycles By GEORGE W. STADLER University of Newcastle upon Tyne I have received numerous

### 7 STOCHASTIC GROWTH MODELS AND REAL BUSINESS CYCLES

Economics 314 Coursebook, 2010 Jeffrey Parker 7 STOCHASTIC GROWTH MODELS AND REAL BUSINESS CYCLES Chapter 7 Contents A. Topics and Tools... 1 B. Walrasian vs. Keynesian Explanations of Business Cycles...

### Financial Development and Macroeconomic Stability

Financial Development and Macroeconomic Stability Vincenzo Quadrini University of Southern California Urban Jermann Wharton School of the University of Pennsylvania January 31, 2005 VERY PRELIMINARY AND

### 1 A simple two period model

A QUICK REVIEW TO INTERTEMPORAL MAXIMIZATION PROBLEMS 1 A simple two period model 1.1 The intertemporal problem The intertemporal consumption decision can be analyzed in a way very similar to an atemporal

Agenda What is a Business Cycle? Business Cycles.. 11-1 11-2 Business cycles are the short-run fluctuations in aggregate economic activity around its long-run growth path. Y Time 11-3 11-4 1 Components

### Charles I. Jones Maroeconomics Economic Crisis Update (2010 års upplaga) Kurs 407 Makroekonomi och ekonomisk- politisk analys

HHS Kurs 407 Makroekonomi och ekonomisk- politisk analys VT2011 Charles I. Jones Maroeconomics Economic Crisis Update Sebastian Krakowski Kurs 407 Makroekonomi och ekonomisk- politisk analys Contents Overview...

### Inflation. Chapter 8. 8.1 Money Supply and Demand

Chapter 8 Inflation This chapter examines the causes and consequences of inflation. Sections 8.1 and 8.2 relate inflation to money supply and demand. Although the presentation differs somewhat from that

### DECONSTRUCTING THE SUCCESS OF REAL BUSINESS CYCLES

DECONSTRUCTING THE SUCCESS OF REAL BUSINESS CYCLES EMI NAKAMURA* The empirical success of Real Business Cycle (RBC) models is often judged by their ability to explain the behavior of a multitude of real

### Universidad de Montevideo Macroeconomia II. The Ramsey-Cass-Koopmans Model

Universidad de Montevideo Macroeconomia II Danilo R. Trupkin Class Notes (very preliminar) The Ramsey-Cass-Koopmans Model 1 Introduction One shortcoming of the Solow model is that the saving rate is exogenous

### New Keynesian Theory. Graduate Macroeconomics I ECON 309 Cunningham

New Keynesian Theory Graduate Macroeconomics I ECON 309 Cunningham New Classical View of Keynesian Economics Failure on a grand scale. Made up of ad hoc assumptions, not built on a strong foundation of

Advanced Macroeconomics (ECON 402) Lecture 8 Real Business Cycle Theory Teng Wah Leo Some Stylized Facts Regarding Economic Fluctuations Having now understood various growth models, we will now delve into

### Dynamic Macroeconomics I Introduction to Real Business Cycle Theory

Dynamic Macroeconomics I Introduction to Real Business Cycle Theory Lorenza Rossi University of Pavia these slides are based on my Course of Advanced Macroeconomics II held at UPF and bene t of the work

### Macroeconomics Lecture 1: The Solow Growth Model

Macroeconomics Lecture 1: The Solow Growth Model Richard G. Pierse 1 Introduction One of the most important long-run issues in macroeconomics is understanding growth. Why do economies grow and what determines

### DEPARTMENT OF ECONOMICS WORKING PAPER SERIES

DEPARTMENT OF ECONOMICS WORKING PAPER SERIES 2008-02 McMASTER UNIVERSITY Department of Economics Kenneth Taylor Hall 426 1280 Main Street West Hamilton, Ontario, Canada L8S 4M4 http://www.mcmaster.ca/economics/

### Calibration of Normalised CES Production Functions in Dynamic Models

Discussion Paper No. 06-078 Calibration of Normalised CES Production Functions in Dynamic Models Rainer Klump and Marianne Saam Discussion Paper No. 06-078 Calibration of Normalised CES Production Functions

### Foundations of Modern Macroeconomics Second Edition

Foundations of Modern Macroeconomics Second Edition Chapter 15: Real business cycles Ben J. Heijdra Department of Economics & Econometrics University of Groningen 1 September 29 Foundations of Modern Macroeconomics

### Economic Growth. Chapter 11

Chapter 11 Economic Growth This chapter examines the determinants of economic growth. A startling fact about economic growth is the large variation in the growth experience of different countries in recent

### Noah Williams Economics 312. University of Wisconsin Spring 2013. Midterm Examination Solutions

Noah Williams Economics 31 Department of Economics Macroeconomics University of Wisconsin Spring 013 Midterm Examination Solutions Instructions: This is a 75 minute examination worth 100 total points.

### Total Factor Productivity

Total Factor Productivity Diego Comin NewYorkUniversityandNBER August 2006 Abstract Total Factor Productivity (TFP) is the portion of output not explained by the amount of inputs used in production. The

### Chapters 7 and 8 Solow Growth Model Basics

Chapters 7 and 8 Solow Growth Model Basics The Solow growth model breaks the growth of economies down into basics. It starts with our production function Y = F (K, L) and puts in per-worker terms. Y L

### CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM)

1 CHAPTER 11. AN OVEVIEW OF THE BANK OF ENGLAND QUARTERLY MODEL OF THE (BEQM) This model is the main tool in the suite of models employed by the staff and the Monetary Policy Committee (MPC) in the construction

### ECON 5110 Class Notes Overview of New Keynesian Economics

ECON 5110 Class Notes Overview of New Keynesian Economics 1 Introduction The primary distinction between Keynesian and classical macroeconomics is the flexibility of prices and wages. In classical models

Real Business Cycle Theory Barbara Annicchiarico Università degli Studi di Roma "Tor Vergata" April 202 General Features I Theory of uctuations (persistence, output does not show a strong tendency to return

### Lecture 1: Asset pricing and the equity premium puzzle

Lecture 1: Asset pricing and the equity premium puzzle Simon Gilchrist Boston Univerity and NBER EC 745 Fall, 2013 Overview Some basic facts. Study the asset pricing implications of household portfolio

### Demand Shocks and Open Economy Puzzles

Demand Shocks and Open Economy Puzzles Yan Bai and José-Víctor Ríos-Rull University of Rochester, University of Minnesota CSWEP 2015 Bai, Ríos-Rull (Rochester, Minnesota) Demand Shocks and Open Economy

### Chapter 1. Vector autoregressions. 1.1 VARs and the identi cation problem

Chapter Vector autoregressions We begin by taking a look at the data of macroeconomics. A way to summarize the dynamics of macroeconomic data is to make use of vector autoregressions. VAR models have become

### Testing Real Business Cycle Models in an Emerging Economy

Draft For comments only Testing Real Business Cycle Models in an Emerging Economy Raphael Bergoeing* Raimundo Soto** June 15, 2000 * Ilades-Georgetown University ** Banco Central de Chile and Ilades-Georgetown

### Optimal Social Insurance Design: UI Benefit Levels

Florian Scheuer 4/8/2014 Optimal Social Insurance Design: UI Benefit Levels 1 Overview optimal insurance design, application: UI benefit level Baily (JPubE 1978), generalized by Chetty (JPubE 2006) optimal

### ECON 5010 Class Notes Business Cycles and the Environment

ECON 5010 Class Notes Business Cycles and the Environment Here, I outline a forthcoming paper by Garth Heutel in the Review of Economic Dynamics. The title is "How Should Environmental Policy Respond to

### 4. Only one asset that can be used for production, and is available in xed supply in the aggregate (call it land).

Chapter 3 Credit and Business Cycles Here I present a model of the interaction between credit and business cycles. In representative agent models, remember, no lending takes place! The literature on the

### Neoclassical growth theory

Chapter 1 Neoclassical growth theory 1.1 The Solow growth model The general questions of growth: What are the determinants of long-run economic growth? How can we explain the vast differences in both output

### Dynamics of Small Open Economies

Dynamics of Small Open Economies Lecture 2, ECON 4330 Tord Krogh January 22, 2013 Tord Krogh () ECON 4330 January 22, 2013 1 / 68 Last lecture The models we have looked at so far are characterized by:

### Sovereign Defaults. Iskander Karibzhanov. October 14, 2014

Sovereign Defaults Iskander Karibzhanov October 14, 214 1 Motivation Two recent papers advance frontiers of sovereign default modeling. First, Aguiar and Gopinath (26) highlight the importance of fluctuations

### Estimating baseline real business cycle models of the Australian economy

Estimating baseline real business cycle models of the Australian economy Don Harding and Siwage Negara y University of Melbourne February 26, 2008 1 Introduction This paper is concerned with the issues

### This paper is not to be removed from the Examination Halls

~~EC2065 ZA d0 This paper is not to be removed from the Examination Halls UNIVERSITY OF LONDON EC2065 ZA BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the Social Sciences,

### Topic 5: Stochastic Growth and Real Business Cycles

Topic 5: Stochastic Growth and Real Business Cycles Yulei Luo SEF of HKU October 1, 2015 Luo, Y. (SEF of HKU) Macro Theory October 1, 2015 1 / 45 Lag Operators The lag operator (L) is de ned as Similar

### Fourth Edition. University of California, Berkeley

Fourth Edition University of California, Berkeley Introduction Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Epilogue References

### Volatility, Productivity Correlations and Measures of. International Consumption Risk Sharing.

Volatility, Productivity Correlations and Measures of International Consumption Risk Sharing. Ergys Islamaj June 2014 Abstract This paper investigates how output volatility and productivity correlations

### Financial Shocks, Cyclicality of Labor Productivity and the Great Moderation

Financial Shocks, Cyclicality of Labor Productivity and the Great Moderation October 28, 2014 Abstract The nature of the business cycle has sharply changed since the onset of great moderation with decline

### 5 Comparison with the Previous Convergence Programme and Sensitivity Analysis

5 Comparison with the Previous Convergence Programme and Sensitivity Analysis 5.1 Comparison with the Previous Macroeconomic Scenario The differences between the macroeconomic scenarios of the current

### The Global Impact of Chinese Growth

The Global Impact of Chinese Growth by Ippei Fujiwara, Keisuke Otsu, and Masashi Saito 2008 International Conference: Frontiers in Monetary Theory and Policy Discussion by Selo Imrohoro¼glu USC Marshall

### MA Macroeconomics 10. Growth Accounting

MA Macroeconomics 10. Growth Accounting Karl Whelan School of Economics, UCD Autumn 2014 Karl Whelan (UCD) Growth Accounting Autumn 2014 1 / 20 Growth Accounting The final part of this course will focus

### Employment Protection and Business Cycles in Emerging Economies

Employment Protection and Business Cycles in Emerging Economies Ruy Lama IMF Carlos Urrutia ITAM August, 2011 Lama and Urrutia () Employment Protection August, 2011 1 / 38 Motivation Business cycles in

### On the Dual Effect of Bankruptcy

On the Dual Effect of Bankruptcy Daiki Asanuma Abstract This paper examines whether the survival of low-productivity firms in Japan has prevented economic recovery since the bursting of the financial bubble

### Real-Business-Cycle Models and the Forecastable Movements in Output, Hours, and Consumption

Real-Business-Cycle Models and the Forecastable Movements in Output, Hours, and Consumption Julio J. Rotemberg; Michael Woodford The American Economic Review, Vol. 86, No. 1. (Mar., 1996), pp. 71-89. http://links.jstor.org/sici?sici=0002-8282%28199603%2986%3a1%3c71%3armatfm%3e2.0.co%3b2-y

### Technology and Economic Growth

Technology and Economic Growth Chapter 5 slide 0 Outline The Growth Accounting Formula Endogenous Growth Theory Policies to Stimulate Growth The Neoclassical Growth Revival Real wages and Labor Productivity

### Interest Rates and Real Business Cycles in Emerging Markets

CENTRAL BANK OF THE REPUBLIC OF TURKEY WORKING PAPER NO: 0/08 Interest Rates and Real Business Cycles in Emerging Markets May 200 S. Tolga TİRYAKİ Central Bank of the Republic of Turkey 200 Address: Central

### Towards a Structuralist Interpretation of Saving, Investment and Current Account in Turkey

Towards a Structuralist Interpretation of Saving, Investment and Current Account in Turkey MURAT ÜNGÖR Central Bank of the Republic of Turkey http://www.muratungor.com/ April 2012 We live in the age of

### Working Capital Requirement and the Unemployment Volatility Puzzle

Working Capital Requirement and the Unemployment Volatility Puzzle Tsu-ting Tim Lin Gettysburg College July, 3 Abstract Shimer (5) argues that a search-and-matching model of the labor market in which wage

### Figure 1: Real GDP in the United States 1875-1993

Macroeconomics Topic 2: Explain the role of capital investment, education, and technology in determining economic growth. Reference: Gregory Mankiw s Principles of Macroeconomics, 2 nd edition, Chapter

### Macroeconomic Theory I Economic Growth and Business Cycles

Macroeconomic Theory I Economic Growth and Business Cycles GOALS Our goal in this course is to understand tools, models and techniques one needs to know in order to read and write academic papers in macroeconomics.

### In ation Tax and In ation Subsidies: Working Capital in a Cash-in-advance model

In ation Tax and In ation Subsidies: Working Capital in a Cash-in-advance model George T. McCandless March 3, 006 Abstract This paper studies the nature of monetary policy with nancial intermediaries that