Return to Capital in a Real Business Cycle Model

Abstract

Can the neoclassical growth model generate fluctuations in the return to capital similar to those observed in the United States? Equating stock market returns with the return to capital, the bulk of the literature concludes that it cannot. This article makes two contributions. First is an equivalence for the neoclassical growth model between a stock market return and a return based on income and capital stock data. While the stock market return is extremely volatile, the income-based return is not. Second is the finding that the neoclassical growth model with shocks to labor productivity alone can account for the bulk of the observed volatility of the income-based return to capital (expressed relative to the volatility of income) but little of the volatility of the stock market return. Simultaneously explaining the volatility of the two measures of the return to capital within the neoclassical model will require a theory of the stock market that breaks our return-equivalence results.