How Saline is the Solow Residual?: Debating Real Business Cycles in the 1980s and 1990s

Abstract

In a 1957 paper, Robert Solow exploited the mathematical properties of the aggregate production function to isolate the role of disembodied “technical change” in economic growth. Solow’s method allowed to disentangle the role of technical change from that of production factors, with the residual serving as a measure of total factor productivity growth. His method and results were equally met with praise and criticism, some focused on the use of an aggregate production function, the residual composition and measurement errors. The interrogations around the residual gave rise to an abundant literature from the late 1950s which made it possible to improve the technique of calculation and refine the results. In this paper, I argue that in the 1980s, debates around the Solow residual were not essentially different from those which took place in the 1950s and 1960s (measurement issues, increasing returns to scale or procyclical productivity). They both have blossomed within the National Bureau of Economic Research (NBER), they both highlight and are central to the macroeconomics controversies of the decade and its resolution in a 1990s consensus. Though, these debates have been accompanied by a change in the “epistemic status of shocks” (Duarte and Hoover 2009, 228) in economics, which redesigned the Solow residual from a source of secular growth to be quantified to the initial impulse of short-term economic fluctuations. I allege that it was the ability to decompose the residual theoretically and empirically that made it a weapon in the war between those believed the business cycle was driven by supply-side factors (Freshwater) vs demand-side factors (Saltwater).