Econ 488: The Advanced Macro Adventure!

I don’t know why, but for some reason I’ve been really sensitive to when writers are using passive voice. This article was FULL of it, making it sound very obscured. Second, I think that some of the assumptions that these writers make are the result of being surrounded by like-minded people. Researchers who cloister themselves  in academia and have no social interaction outside of it have a skewed perception of how the world operates. In particular, at one point in the article they said that since an article was published, it can be considered part of agents’ consciousness. They do a very good job of categorizing key variables to form comprehensive equations - specifically  where they state that the state of the economy can be measured by policy variables, decision variables, and random shocks. While I disagree with the assumptions that they make in order to generate these points, they make their general principle easier to conceptualize. Perhaps with more realistic assumptions, this technique would be more valuable.

The conclusions Kydland and Prescott draw are similar to the reading we have done in
Comparative this semester. They state at the end that constitutional rules should be made costly in order to ensure political stability. This is what Ostrom states in her book - however, she does allow operational rules to be altered more readily. With political stability, individuals will be more likely to adopt strategies in response to a change in the environment (which in this case could be a metaphor for a “technological” shock). Had I read this article without any prior notion of what RBC theory indicated and assumed, I think I would have found the conclusions realistic. I do feel that they oversimplify, but I wonder: if this had been my only exposure to RBC, would I have supported its general ideas?

I’m trying very hard to be open-minded about reading from schools of thought that I disagree with. That is why I’m not tearing this article to shreds. While I find a lot of it BS, I think the end product is on the right track.

    The first several pages of this article are fragmented summaries of prior RBC research. The only parts I could recognize as being Stockman’s thoughts were lists he made of similarities and virtues of RBC theory. He was also more interested in reporting the actual numbers found by different research than explaining their significance, which just added to my general dismay and confusion. His main argument in favor of RBC theory is that it can be used to explain how shocks will impact the economy between quarters. When describing the parameters for RBC, he includes focuses on rates more than static variables, which may be more beneficial for forecasting using these models. Specifically, he discusses the discount rate (how individuals value the future), the rate of capital depreciation, substitution in consumption and leisure, etc. In reality, I think that at best these could be used to forecast only one quarter into the future as they are limited in their progression. However, if someone can figure out a way for me to substitute 150% of my time for leisure, I am all ears.

One of the more interesting points in Stockman’s extensive lit survey relate to how business cycles relate to long run growth. He believes that the LR and SR growth are interrelated. SR trends are also called nonstationary movements, around the LR (stationary) trend. Some even argue that variation in SR trends may actually be indicative of a change in LR behavior. Further research also compared seasonal fluctuations to the business cycle, finding a high correlation between them. This indicates that business cycles may not be completely random, but rather the manifestation of rational behavior given seasonal phenomena (such as consumers buying more during Christmas season).

Stockman then has an incredibly defensive section where he outlines different arguments against RBC theory. Particularly in his discussion of the incredibility of technology shocks, his most compelling argument is that he doesn’t see anyone else coming up with a better idea. The only arguments that he really seems to take seriously are those which state that monetary changes impact business cycles (which makes sense, considering he worked for the Cleveland Fed).

Ultimately, he remains ambiguous in his discussion of the role of monetary policy. While recessions may be uncomfortable, he holds that they may just be individuals and firms rationally adjusting their behavior to the optimal level. Nonetheless, he believes that monetary shocks are possible, and in those instances monetary policy may be used effectively. But since economists don’t really know how business cycles work, they shouldn’t do anything until they figure it out. Excellent.

Stockman, Alan C. 1988. “Real Business Cycle Theory: a Guide, an Evaluation, and New Directions.” Cleveland Federal Reserve Quarterly Journal.
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My parents want me to focus on my studies and therefore give me money to pay for groceries, rent, and medical stuff. My mom has, rather forcibly at times, expressed interest in paying for my gas, but I have refused. Therefore, gas is the only necessity that I really pay for. Earlier today, I dropped 10 extra dollars on gas, meaning my real wage has decreased. Therefore I will choose to work less in the coming weeks until my job will offer me a higher real wage… No I won’t, will I?! I’m going to work extra hard despite the havoc it will wreak on my school work.

I also made baked apples this evening.

 This article is a reasonably causal yet skeptical assessment of real business cycles. Mankiw briefly describes varying degrees to which real business cycle advocates take their theory, beginning with those who use it as an indicator for the infallibility of hardcore classical economics. These economists believe that nominal variables are completely irrelevant and have no impact on the economy whatsoever; markets will always clear due to real variables alone. Business cycles, therefore, occur as the result of fluctuations in the level of available technology and because of a change in individual production functions between leisure and goods. The leisure-goods trade off is especially problematic as the idea contrasts empirical evidence. For example, in a recession, people consume less and increase their leisure time, and the opposite occurs in a boom. If both of these are normal goods (as real business cycle theory assumes), their reactions should coincide when confronted with the same economic stimulus.  This is where technology steps in to save the day. Real business cyclists argue that recessions occur when technology becomes less productive, which decreases the marginal product of labor and therefore the real wage. As a result, people will both decrease their consumption and increase their leisure. Interesting theory, but Mankiw isn’t having it - as a Keynesian, he believes that unemployment is caused by market inefficiencies, and that individuals are not making a conscious choice to enjoy more leisure by responding to fluctuations in real variables.

More lenient cyclists* treat economic shocks as incidents that are specific to one or a few industries, as opposed to the aggregate economy. The regression of technology in one industry effects aggregate wealth, and leads to a recessing business cycle. Another explanation for this notion states that recessions are caused by adjustment within the labor market as individuals find it less rewarding to work in one industry in relation to another. A recession in this case would be the result of this adjustment in the labor market. The second interpretation works well with Keynesian theory, since the only detail that differs between the two theories is the idea of whether workers are unemployed voluntarily or involuntarily in such situations. Cyclists argue that workers are merely attempting to maximize their utility by switching to a more financially rewarding job. However, in that case recessions would be coupled with a large number of job vacancies, which they are not. Instead, high unemployment coincides with low labor demand, indicating involuntary unemployment that Keynesians believe in. Cyclists also suspect that money has no impact on the real economy, and that instead money reacts to variation in output and never vice versa.

Real Business Cycle Theory provides an interesting way of looking at the short run behavior of the aggregate economy, but severely lacks convincing empirical data. I do like how it challenges generally accepted directions of causality, despite the fact that they lack evidence to support their ideas.  Why does the money supply necessarily have to effect output? They appear to provide logical, inductive reasoning as to why this and other assumptions may not be true as they are understood, but fail to fully support them. They appear to have been stirring things up in economic theory just for the hell of it, ultimately. Mankiw’s final remarks state that real business cycle theory has internal consistency and credibility, but lacks external consistency (which is real evidence). Perhaps I would have a deeper appreciation for the theory if I hadn’t read an article written by a critic, but nonetheless I enjoyed learning about cyclist rationale.

*I’m not brick dumb; I know that cyclists are people riding bicycles. I felt like shortening the term “Real business cycle economists” and “cyclists” was the most amusing alternative that flashed through my mind.

Mankiw, N. Gregory. 1989. “Real Business Cycles: A new Keynesian perspective.” In Journal of Economic Perspectives 3, Summer: 79-90.