“Understanding Real Business Cycles”
by Charles I. Plosser
Presented by:
Lizzie Dies
Wade Letter
Adam Vande Zande
Key Questions Addressed
• Can current shocks have implications for future decisions
and/or outcomes?
• What different factors does RBC look at compared to other
methods?
• How close does the model get to actual data?
Main Points
• Focuses of Neoclassical vs. ISLM vs. Real Business Cycle
• Model can be accurate with some variables but off with others
• Difference – Real Business Cycles look at productivity shocks
and other variables
• Neoclassical precursor for RBC
Outline of the Presentation
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Background Information
Neoclassical Model
Robinson Crusoe
Productivity Disturbances
Economic Growth & Business Cycles
Real Business Cycles 1954-1985
Model Data
Productivity Shift Graphs
Real Business Cycle Research
Background Information
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1960s & 1970s
Keynesian model vs. Business Cycles
“Idealized state of dynamic equilibrium”
Transform into more neoclassical
Neoclassical Model
• Most basic model of economic dynamics
• Benchmark model
• Simple economic environment to consider
• Households live forever
• Utility of each agent is function of consumption & leisure
• Maximize utility F(C,L)
• Labeled a “real business cycle model”
Robinson Crusoe
• Crusoe’s choice problem is to maximize his lifetime utility
• If there were no productivity disturbances…
• Model imposes resource constraints
• C+I≤Y
• L+N≤1
• C, L, N, K, I are all positive
Robinson Crusoe (cont.)
• First Order Conditions
• Linearize (approximations)
• Constant Parameters  α = .58; ᵦ = .95; ᵹ = .10
Productivity Disturbances
• Observes a temporarily high value of productivity…
• Consume more output in current period
• Also value future consumption and leisure
• Temporary vs. Permanent
• Temporary - substitution current for future work, and
current consumption for leisure, wealth higher, higher
output, consumption and leisure in the future
• Permanent - raise wealth, less incentive to increase
investment, more incentive for current consumption,
less incentive to work harder today
• Output and consumption are likely to be correlated
• Government actions?
Economic Growth & Business Cycles
• Neoclassical model of capital accumulation predicts that per
capita values of output, capital and consumption will converge
to constants.
• Solow – major factors
• Nelson and Plosser argue that real per capita output behaves
as if they have random walk components. They also argue that
Solow’s technology series behaves like a random walk.
• The fact that productivity grows over time raises additional
complications
Productivity Shifts
• Need to obtain some measure of the productivity shocks.
• Figure 1 is the annual percentage rate of change in technology.
Real Business Cycles 1954-1985
• Simple neoclassical model described earlier is clearly an
incomplete model of the U.S. Economy.
• Table 1 highlights some of the statistical properties of postwar
business fluctuations.
Real Business Cycle Research
• Multi-Sector Extension
• Labor Markets
• Endogenous Growth
• Money
• Strategies
Conclusions
• Basic framework of RBC is the neoclassical model
• The model is accurate for some variables but not others
• Real technology shocks have occupied the central focus, but
other shocks are being studied
• Real business cycle theory is still in its infancy
• Much work remains before economists have a full
understanding of RBC