Abstract
Up until now, we discussed the way in which the New Classical (henceforth, NC) economics restored and brought to centre stage the idea of cyclical fluctuations on the basis of the assumption of continuous market clearing in all markets and the rational expectation hypothesis that characterises the behaviour of the economic agents. According to NC economists, the lack of adequate information on the difference between relative prices and the general price level as well as the monetary shocks constitutes the major causes of fluctuations in the real GDP. This explanation of the source of business fluctuations, on the one hand, questioned the Keynesian orthodoxy and, on the other hand, paved the way for the emergence of the Real Business Cycles (henceforth, RBC) and the New Keynesian economics. This chapter begins with a history of the discussion of business cycles and continues with the major characteristics of the RBC approach, while the causes (real or monetary) of business cycles and the separation of cycles from growth (trend) follow. A short description of the RBC simulation models as well as the policy implications of the real business cycles is the next topic, and the chapter concludes with a summary and some critical remarks about the approach that has attracted a lot of attention at least up until the outbreak of the crisis of 2008.
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Notes
- 1.
Among the most important representatives of this approach are included: Edward Prescott (Minnesota), Finn Kyndland (Carnegie-Mellon), Charles Plosser, John Long, Robert King, Alan Stockman, Sergio Rebelo (all from the university of Rochester) and Robert Barro (Harvard).
- 2.
This approach cannot include changes in demand, such as change in preferences or government policies; the effects of these changes are considered to be strictly limited (Ploser 1989, p. 57).
- 3.
Robert J. Gordon characterised this possibility of presenting concisely many competing views in terms of slopes of two curves as “the paradox of convergence without agreement”.
- 4.
Solow’s residual is determined in an economy that functions in conditions of perfect competition and constant returns to scale by using the following form of production function Y = AF(K, L), where A represents the exogenous technological change or the productivity shock. For the estimation of Solow’s residual, we hypothesise a Cobb–Douglas production function Y = AF(K, L) = AK a L 1−a. We assume constant income shares for the factors of production with the share of capital, a = 0.3. If we further suppose discrete time with dt = Δt = 1, then we arrive at the following relationship: ΔA/A = ΔY/Y−[aΔK/K−(1−a) ΔL/L], where ΔA/A is the growth rate of the Solow’s residual.
- 5.
The data for the growth of the real GDP in the US economy 1980–2004 and the total factor productivity come from The Groningen Growth and Development Centre (http://www.ggdc.net).
- 6.
Henceforth, when we refer to variables such as GDP and investment, we mean the real and not the nominal magnitudes.
- 7.
We say that the time series data variable y follows a random walk or it has a unit root if b = 1. In such a case, we know that the variable, with the passage of time, drifts away from the equilibrium position.
- 8.
- 9.
One should not be surprised by this assumption since at the University of Chicago (where Lucas comes from) there is a long tradition according to which markets operate so efficiently that the performance of the economy is surprisingly close to that expected by perfect competition. This was the reason why Milton Friedman, George Stigler and Arnold Harberger (all from the University of Chicago) opposed the antimonopoly legislation and government regulation of the markets. The idea being that the antimonopoly legislation, in general, cannot achieve economic results quite different from the prevailing ones, which are not far from those predicted by the perfectly competitive model.
- 10.
It is ironic for a school of economic thought that endorses an outright rejection of business cycles to call itself the Real Business Cycles approach.
- 11.
In an early version of this chapter in Greek (Tsoulfidis 2004) we argued that the RBC will continue to be popular to the extent that the economies are expanding, if however, the economies fall in a serious recession then as the RBC approach would not have any serious economic policies to propose naturally one would expect its decay.
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Tsoulfidis, L. (2009). The Real Business Cycles Approach. In: Competing Schools of Economic Thought. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-92693-1_15
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DOI: https://doi.org/10.1007/978-3-540-92693-1_15
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