Theories and Methods of the Business Cycle.Part 1: Dynamic Stochastic General Equilibrium ModelsIV. Can RBC be saved?

Jean-Olivier HAIRAULT, Professeur à Paris I Panthéon-Sorbonne et à l’Ecole d’Economie de Paris (EEP)

IV. 1. Extending the RBC approach

Two kinds of extensions: solving empirical puzzles and

investigating other issues.

Some criticisms have been adressed into the RBC theory,

ie. models where productivity shocks are the main

perturbation of optimal fluctuations.

The canonical model has been extended to international

fluctuations and to the study of particular historical

episodes like the 1930’s crisis.

IV. 2. Public spending shocks

E

E’

E’’

w

Ns, Nd

IV. 2. Public spending shocks

Government shocks have wealth effects which alters labor

supply. The correlation between wages and hours is then

negative in case of government shocks.

Taking into account both shocks leads to decrease this

correlation.

E

E’

E’’

IV. 2. Public spending shocks

IV. 2. Public spending shocks

Business cycles properties with public expenditures shocks

From kprdea2.m to kprdea2G.m

The correlation between hours and wages is decreased but

remains too high. Public expenditures shocks have a

weaker impact on aggregates than technology shocks.

Artificially decreasing the volatility of the technology shocks

could lead to a negative correlation.

IV. 2. Public spending shocks

Only Technology Shocks N Y C I P

standard deviation 0.0081 0.0142 0.0050 0.0523 0.0066

relative st. dev. 0.5667 1.0000 0.3480 3.6733 0.4655

Correlation 0.9745 1.0000 0.8910 0.9864 0.9623

serial corr. 0.6750 0.6924 0.7972 0.6770 0.6924

correlation N-W 0.8770

+public spending shocks

standard deviation 0.0069 0.0134 0.0062 0.0486 0.0074

relative st. dev. 0.5187 1.0000 0.4634 3.6346 0.5519

Correlation 0.9290 1.0000 0.8569 0.9816 0.9380

serial correlation 0.6808 0.6920 0.7715 0.6798 0.6920

correlation N-W 0.7441

IV. 3.Back to the Lucas critique

IV. 3.Back to the Lucas critique

IV. 3.Back to the Lucas critique

RBC methodology allows us to take into account all the

implications of a change in public policy or in the environment of

private agents.

The dynamics derive from the interaction between the

environment (shocks, public policies) and fundamentals

(Technology, preferences).

Which public spending rule does better stabilize the economy?

Volatility ? Which volatility?

Welfare? What are the market failures in our economy?

What are the size of business cycle costs? More on this issue in

course 6.

IV. 4. The indivisible labor hypothesis

IV. 4. The indivisible labor hypothesis

IV. 4. The indivisible labor hypothesis

IV. 4. The indivisible labor hypothesis

IV. 4. The indivisible labor hypothesis

Ns

Nd

IV. 4. The indivisible labor hypothesis

Eta=1 N Y C I P

standard deviation 0.0081 0.0142 0.0050 0.0523 0.0066

relative st. dev. 0.5667 1.0000 0.3480 3.6733 0.4655

Correlation 0.9745 1.0000 0.8910 0.9864 0.9623

serial corr. 0.6750 0.6924 0.7972 0.6770 0.6924

correlation N-W 0.8770

Infinite elasticity

standard deviation 0.0124 0.0170 0.0057 0.0638 0.0057

relative st. Dev. 0.7270 1.0000 0.3329 3.7442 0.3329

Correlation 0.9750 1.0000 0.8759 0.9865 0.8759

serial correlation 0.6706 0.6883 0.8034 0.6727 0.6883

correlation N-W 0.7472

IV. 5. Capital utilization

IV. 5. Capital utilization

IV. 5. Capital utilization

IV. 5. Capital utilization

IV. 5. Capital utilization

IV. 6. Labor Hoarding

Taking into account the quality or intensity of worked hours

labor intensity increases (decreases) in expansions (contractions).

Firms prefer to adjust labor intensity rather employment.

Individual hours are assumed to be indivisible and employment

are submitted to adjustment costs. Employment gets

predetermined.

Productivity cycle: labor productivity measured as

output/employment leads employment in the data.

Correlation lagged and contemporanous productivity-

employment: .11 0.37 0.47 0.47 0.34

IV. 6. Labor Hoarding

Y = A F(K, X(eH))

The Solow Residual is no longer a pure measure of

technology: variations of e must be eliminated.

Naive Solow residual overestimates the standart deviation

of the technology innovation by 35%, as estimated by

Burnside, Christiano and Rebelo.

Technology shocks are not volatile enough to replicate the

variance of output. Only 58%.

Adding another real shock: public spending.

IV. 7. International Business Cycles

Backus, Kehoe and Kydland [1992], Journal of Political Economy,

Baxter [1995], Hanbook of International Economics

More failures than in closed economies due to capital

international mobility and portfolio diversification…but at the

origin of the new open economy macroeconomics, Obstfeld and

Rogoff [1995]. I will present some international RBC models in the

open macroeconomics course…

IV. 7. International Business Cycles

After a technology shock abroad, aggregates increase as in the closed RBC

economy.

As the capital return is higher abroad, domestic households invest abroad:

the capital stock decreases in the domestic country, and so the labor

demand decreases too. This explains why the model predicts a negative

correlation between production factors across countries.

Output across countries is then less correlated in the model than in the

data.

As there is perfect risk-sharing (complete markets), the marginal utility of

consumption is equalized across countries: the wealth distribution does

not vary over the business cycle. In case of positive shock abroad, the

domestic receives a payment provided by a state-contingent security.

Consumption across countries is then more correlated in the model than in

the data.

IV. 8. The Great Depression

Special issue of the Review of Economic Dynamics in 2002

investigating the 1930’s crisis in the main developed

countries using the RBC model

P. Beaudry and F. Portier [2002], RED, The French

Depression in the 1930’s

IV. 8. The Great Depression

IV. 8. The Great Depression

IV. 8. The Great Depression

IV. 8. The Great Depression

IV. 8. The Great Depression

IV. 8. The Great Depression

IV. 9. Business Cycles Accounting

IV. 9. Business Cycles Accounting

IV. 9. Business Cycles Accounting