The Keynesians attribute business cycle fluctuations to



The Keynesians attribute business cycle fluctuations to
 The Keynesians attribute business cycle fluctuations
to what they regard as the fundamental instability of
private spending--especially investment and consumer
durable goods expenditure.
 The New Classical view holds that unanticipated
changes in monetary growth are the primary cause of
deviations from the “natural rate” of output and
Real Business Cycle theorists claim business cycles
can be explained as an optimizing response of economic
agents to random productivity shocks.
This is a tough
model to explain
to non-economists
consumption and
leisure subject to
Constraints include
the number of hours
in a day and the
resource prices (such
as the wage).
Maximize profits subject
to constraints
Constraints include prices
of outputs and inputs, and
Constrained optimization problem for an infinitely-lived
“representative” consumer-producer.
Charles Plosser. “Understanding Real Business Cycles,” Journal of
Economic Perspectives, Summer 1989, pp. 51-73.
l    [u (Ct ,1  Nt )]   t[tF ( Kt , Nt )  Ct  Kt  1)  (1   ) Kt ]
t 0
t 0
If t increases, that
means you can get
L is the LaGrangean function
more output from
Ct is consumption in period t
the same stock
Nt is work in period t
of capital and work effort
1- Nt is leisure in period t
Kt is the capital stock in period t
 is the depreciation rate per period
t is a “shift factor” that alters total factor productivity in period t.
 is the time preference parameter, where 0<  < 1; and
t is the LaGrangean multiplier in time t.
When productivity rises,
the opportunity cost of
leisure (measured in forgone
output) rises, which induces the
representative agent to
substitute work for leisure.
Hence the random
productivity shock brings about
an expansion of real output.
The intertemporal
substitution of work for
leisure (and vice versa) in
reaction to technology
shocks is the principal
force underlying business
cycle expansions and
The problem for Plosser, Finn Kydland, and other Real
Business Cycle theorists is to provide plausible estimates
of t or “total factor productivity.”
The methods used
to perform these
estimates have been
widely criticized
Annual productivity growth
Policy implications of Real Business Cycle theory
 Some economists take the theory to mean that
countercyclical aggregate demand management is
doomed to ineffectiveness--since, after all, they claim
that 70 percent of the deviation of real output from trend
in the postwar era is explained by productivity shifts.
Technological change is a factor that policy makers
cannot control.
Chatterjee explains that the Central Bank (the “FED”
in the U.S.) should nevertheless exercise its stabilizing
function in financial markets.

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