Intertemporal Macro: real business cycles Flashcards
What is the definition of a Business Cycle?
Temporary and recurrent deviations of output and employment from trend.
What is a pro-cyclical variable?
A variable whose cyclical component is positively correlated to output.
What are key RBC model assumptions?
Perfect competition, perfect information, flexible prices/wages, rational expectations, supply shocks drive cycles.
What causes business cycles in RBC models?
Randomness in exogenous technological progress (supply shocks).
What is the Solow Residual?
A measure of output changes unexplained by changes in inputs; used to proxy technology.
What happens after a positive productivity shock with no persistence (ρ = 0)?
MPL rises, wages rise, labour supply increases, part of output is invested, and economy returns to steady state.
How does a persistent productivity shock (ρ > 0) affect the economy?
Effects drawn out over time, higher initial real interest rate, consumption hump-shaped adjustment, delayed capital accumulation effects.
Why is capital accumulation a weak transmission mechanism in RBC?
It causes only gradual adjustment and does not closely match real data on business cycles.
Why are AD shocks problematic in RBC models?
They imply countercyclical consumption, contrary to empirical data.
What are three main empirical failures of RBC models?
- Insufficient employment volatility, 2. Too strong wage-employment correlation, 3. Short unemployment deviations.
What is the criticism of using the Solow Residual in RBC?
It may capture factors like labour hoarding and market imperfections, not just technology shocks.
Why is labour modelling criticized in RBC models?
Observed labour market fluctuations do not match the predicted intertemporal substitution patterns.
What are key criticisms about the shocks used in RBC models?
Shocks may represent omitted variables; large and frequent shocks needed are unrealistic.
What did Kydland and Prescott (1982) find about hours worked?
Aggregate hours worked are more variable than productivity, conflicting with RBC predictions.
How does a positive productivity shock impact interest rates?
Initially raises real interest rates, later falls below steady-state as capital accumulates.
What is meant by ‘shock persistence’ in RBC models?
The tendency of technology shocks to have long-lasting effects; necessary for realistic business cycles.
