About: Real Business Cycles theory   Sponge Permalink

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Real Business Cycles (RBC) theory views cycles as arising in frictionless perfectly competitive economies with generally complete markets subject to real shocks (random changes in technology or productivity), it makes the argument that cycles are consistent with competitive general equilibrium environments in which all agents are rational maximizers. "In this case, the observed fluctuations in GNP are fluctuations in the natural (trend) rate of output, not deviations of output from a smooth determinist trend." (Snowdon) Typically RBC models have the following features:

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  • Real Business Cycles theory
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  • Real Business Cycles (RBC) theory views cycles as arising in frictionless perfectly competitive economies with generally complete markets subject to real shocks (random changes in technology or productivity), it makes the argument that cycles are consistent with competitive general equilibrium environments in which all agents are rational maximizers. "In this case, the observed fluctuations in GNP are fluctuations in the natural (trend) rate of output, not deviations of output from a smooth determinist trend." (Snowdon) Typically RBC models have the following features:
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  • Real Business Cycles (RBC) theory views cycles as arising in frictionless perfectly competitive economies with generally complete markets subject to real shocks (random changes in technology or productivity), it makes the argument that cycles are consistent with competitive general equilibrium environments in which all agents are rational maximizers. Contrary to what Keynesian, Monetarist, and new classical economicsts believed, RBC theorists, starting with Nelson and Plosser in 1982, found that the hypothesis that GDP growth follows a random walk cannot be rejected. They argued that most of the changes in GDP were permanent, and that output growth would not revert to an underlying trend following a shock. "In this case, the observed fluctuations in GNP are fluctuations in the natural (trend) rate of output, not deviations of output from a smooth determinist trend." (Snowdon) Typically RBC models have the following features: * They use a representative agent framework, thereby avoiding aggregation problems. * Firms and households have explicit objective (utility) functions that they maximize subject to budget and technology constraints. * Cycles are created by exogenous productivity shocks (impulse mechanism), which are amplified by propagation mechanisms such as intertemporal substitution, consumption smoothing, investment lag, or inventory building. Kydland and Prescott’s time-to-build model, for example, assumes that it takes 4 quarters to build capital. They furthermore employ a fatigue effect, which incorporates into the model that more labor in t = 1 will lead to higher preference for leisure in t = 2. * Their basic assumptions are rational expectations, perfect (competitive) markets, and perfect information.
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