Chapter 15
Real Business Cycle
Theory
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summary
? Some facts in business-cycle
? Real-business-cycle theory’s explanation to
some important economic variables
?Explanation to the fluctuations of output,
consumption & investment
?Explanations to employment fluctuation
?Explanations to monetary fluctuation
? Evaluation to Real-business-cycle theory
15.1 Some Facts in Business-Cycle
?Fountainhead of Real-business-cycle theory
?In 1980’s,many papers give explanations to economic
fluctuations by real impacts instead of monetary impacts,
?Representative economists,EDWORD.PRESCOTT,
FENE.KIDLANT,CHARLES.PROSE,JOHN.LONG,
ROBERT.KING & ROBERT.BARO,
?Kiddland-Prose’s paper,Time to Build and Aggregate
Fluctuations,in 1982 begin to form the model,
15.1 Some Facts in Business-Cycle
? Characters of Real-business-cycle theory,
?New developments of new classical economics,inherited
most of the micro assumption.（ 1） use equilibrium
method to construct macroeconomic model；（ 2） adapt
the hypothesis of,rational anticipation”,
?Different from traditional classical theory,attach much
importance to supply instead of monetary fluctuation,The
theory argues that real impacts (for example technology
evolution,policy change and natural disaster) are the
origin of economic fluctuation,
15.1 Some Facts in Business-Cycle
? Business cycle is similar,and the time series data express common rules,
which includes,
? Output fluctuations are related to each other through different
departments with time serial relation；
? Industry product,consumption and investment fluctuate simultaneously with
cycle,and also the government buy；
? Investment changes much more severely than consumption；
? Employment is with the cycle while unemployment is against cycle；
? Real wage and average productivity is with the cycle,and the former is
only slightly；
? Currency supply and stock price is with cycle and lead other elements；
? Inflation and nominal interest is with cycle and lag；
? Real interest is not seasonal,
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? Explanations to the fluctuations of output,
consumption & investment
?Use simplified,Ramsey-Cass-Coopmans” model to
analyze,
?Object functions,
tt1ttttt
t
0i
i
tt
K)1(IK,IC)K(fY.t.s
)]C(u[EUEm a x
?
?
??????
?
?
?
?
?
0f,0f0;u,0u ??????????
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? F.O.C,
? TVC,
)]}1()K('f[)C('u{E)C('u 1t1ttt ?? ????? ??
0]K)C('u[Eli m 1itititt
i
?????
??
?
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? Solve the problem
?assumption,
? Utility function
? Product function
? Depreciation ratio δ =1
?calculate the equation,
tt l n C)C(u ?
?? ttt KA)K(f
?? ??? tt1tttt KAKKAC ???? ?和
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? Brigg's logarithm,we get,
? Simplify the equation again,
tt1t akk ?????
t1-tt acc ??? ?
t1-tt ayy ??? ?
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? If
（ AR1）,then
investment,output and consumption will prove to
be（ AR2）
? In another word,real impacts will affect the output
permanently,
1,aa t1tt ???? ? ???
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
Output obeys AR1
t1
Y
时
间
output’s
departure from
natural ratio is
transient
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
Output obeys AR2
t1
Y
时
间
Technology
impacts affect
output
permanently
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
?calibration method
表 16.3 real data & kiddland-prescott model’s simulation
fluctuation（ standard error） Comparison to simultaneous result
variables real model real model
output 1.76 1.76 - -
consumptio
n
1.29 0.44 0.85 0.85
investment 8.60 5.40 0.92 0.88
Work hours 1.66 1.21 0.76 0.95
Adapt from,Yuan Zhigang,,macroeconomics,（ the
second edition）,page273
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
?Explanations to employment fluctuation
?Lucas & Labin’s hypothesis（ 1969）,
?A rational individual will naturally make
substitutions through times facing wage
fluctuations,when the wage is high,they
prefer to work; when real wage is low,
they will work less,
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? Optimal programme for individual to decide labor
supply,
222111
1
2
2
1
1
1
LWS)r1(C,LWSC.t.s
)
1
1L
ln C(
1
1L
ln Cm a x
?????
?
?
??
?
?
?
??
?
?
?
??
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? Calculate the optimal programme above,we
get,
? It proves that labor supply will be influenced by
relative wage and interest,
???
1
1
2
1
1
2 )
W
W
()]r1([
L
L ?
???
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
? Relative wage and interest’s concrete influence to labor supply,
?Wage mechanism,
?Transient technology impact and real wage change,relative wage
changes make individual substitute through times；
?Permanent technology impact and real wage change, labor supply will
not change
?Interest mechanism,
?A high interest will encourage individual to work more and save more
to substitute future labor,
15.2 Real-Business-Cycle Theory’s
Explanation to Important Economic Variables
?Explanations to monetary fluctuation
?Basic arguments,
?Currency is neutral and monetary policy doesn’t work；
?Currency is the result of business cycle,The positive
relation between currency and output is only the
response to economic activities,
15.3 Evaluation to Real-
Business-Cycle Theory
? contributions
? Display supply impact’s important rule in the form of
business cycle by general equilibrium method,
? deficiency
? As to employment theory,common unemployment in economic
crisis can not be explained by labor’s substitutions through
times；
? The argument Currency is neutral in short terms is
criticized；
? Supply impact caused by technology evolutions is not bond to
be independent from demand fluctuations,
Chapter 15
The End
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