Equilibrium Business Cycle Theory Research Articles

Théories réelles versus monétaires des cycles d’équilibre

After dominance of growth theory for more than two decades, business-cycle theory entered centre stage again in the 1970s. Different attempts, by various authors, have tried to connect these modern contributions to the interwar debates : from Lucas [ 1977], quoting Hayek on the challenge to incorporate cyclical phenomena into the system of economic equilibrium theory, to Plosser [ 1989] defending a purely real approach to business cycles from a methodological point of view. Plosser also referred to Hicks’s position in his controversy with Hayek on the fundamental nature of fluctuations. Despite the success of the modern literature in providing an Equilibrium Business Cycle theory, at first sight it seems that the same (old) debate confronting real versus monetary approaches is still there. A closer inspection shows that the modern tools deeply affected the nature of the arguments. The purpose of this paper is to examine the differences between the interwar and the modern debates on how economic theory deals with fluctuations.

Théories réelles versus monétaires des cycles d'équilibre

Résumé Après la domination de la théorie de la croissance pendant plus de deux décennies, la théorie des cycles occupa de nouveau le devant de la scène dans les années 1970. Certains auteurs tentèrent à plusieurs reprises de relier ces contributions modernes aux débats de l’entre-deux guerres : de Lucas [1977], citant Hayek à propos du défi que représente l’incorporation des phénomènes cycliques dans une théorie du système économique élaborée en termes d’équilibre, à Plosser [1989] défendant une approche purement réelle des cycles sur des bases méthodologiques. Plosser fera sur ce point référence à la position de Hicks dans la controverse qui l’opposa à Hayek concernant la nature fondamentale des fluctuations. En dépit du succès de la littérature moderne à produire une théorie des cycles d’équilibre, il apparaît à première vue que le même débat, déjà ancien, opposant les théories monétaires aux théories réelles des cycles est toujours présent. Une analyse plus poussée montre que les outils modernes de la dynamique ont profondément modifié la nature des arguments. L’objectif de cet article consiste à comparer les débats de l’entre-deux guerres avec ceux des années 1970 concernant l’analyse des fluctuations par la théorie économique.

The role of monetary shocks in equilibrium business cycle theory: Three examples

We study three equilibrium business cycle models that differ according to the mechanism through which monetary growth shocks affect the economy. These include models with inflation tax effects, with staggered nominal wage contracts, and with unanticipated inflation effects. We review some monetary features of business cycles in postwar US data and compare these with the same properties computed for the artificial economies. Our goal is to identify the features of the business cycle that these mechanisms help to explain, the features that remain puzzling, and how the form of the mechanism matters.

Unanticipated Money Growth and the Business Cycle Reconsidered

The role of unanticipated changes in money growth for aggregate fluctuations is reexamined using the methods of quantitative equilibrium business cycle theory. A stochastic growth model with money is constructed in which production and trade take place in spatially separated markets (islands). Following Robert E. Lucas (1972, 1975), individuals only observe prices in their own local market, causing them to confuse changes in the average price level with changes in market specific relative prices. The authors show that this mechanism can lead to large fluctuations in real economic activity. Some aspects of the statistical properties of these fluctuations, however, differ significantly from those describing U.S. business cycles. Copyright 1997 by Ohio State University Press.

Equilibrium Theory and Economic Fluctuations

The popularity of business cycle theories, it is often said, appears to be subject to cyclical fluctuations itself. This paper addresses two of the theoretical problems which might provide reasons for such an observation. The first concerns the reconciliation of business cycle and general equilibrium theory, while the second considers, more generally, the link between short run economic fluctuations and the long run theory of growth. Both topics are addressed by comparing recent theoretical developments with the debate in the interwar period, with an emphasis on Hayek's contribution to business cycle theory. It is argued here that a re-interpretation of Hayek's theory as an attempt to model short run fluctuations where rationality is bounded provides an alternative starting point for modeling path dependent behaviour which is overlooked when Hayek's work is considered a precursor of equilibrium business cycle theory, failing simply for a lack of formal sophistication.

Testing between Competing Models of Real Business Cycles

This paper tests a real business cycle model with efficient long-term labor contracts (the efficient long-term contract model) against a standard real business cycle model (the intertemporal substitution model). In the former model, employment and real wages are determined by bilateral dynamic bargaining between firms and workers. In the latter model, employment and real wages are determined instead by the dynamic optimization of households within the competitive market framework. We estimate each model using aggregate Japanese data. Our results show that the data are consistent with the efficient long-term contract model, but are inconsistent with the intertemporal substitution model. A business cycle phenomenon is typically found in time-series data on employment and real wages. According to the data of almost all developed countries, employment fluctuations are considerably greater than wage fluctuations. Many recent economic studies have attempted to explain this phenomenon. Most of these studies fall into the equilibrium business cycle theory in which business cycles are the result of individual agents optimizing in a competitive environment. Among the most famous early examples of such a theory are the rational expectations, general equilibrium models of Lucas (1972) and Barro (1976) which stress the role of nominal shocks in the presence of imperfect information. More recently, the predominant equilibrium business cycle theory has been the real business cycle model of Kydland and Prescott (1982), Long and Plosser (1983) and King and Plosser (1984) which emphasizes the importance of real shocks to production technology. Real business cycle theory considers a model economy populated by a single infinitely-lived individual with given initial resources, production possibilities and tastes. The representative individual chooses a preferred consumption-production plan and the resulting allocation is Pareto optimal. The implications of real business cycle theory are thus derived from the Pareto optimal equilibrium allocation as calculated from the planning problem of a social planner or representative agent. A policy implication of this theory is that monetary policy has no significant effect

New classical and old Austrian economics: Equilibrium Business Cycle Theory in perspective

The recent flourishing of New Classical economics, and especially its Equilibrium Business Cycle Theory (EBCT), has given a fresh hearing to the Old-but still developing-Austrian Business Cycle Theory (ABCT). While the New and the Old differ radically in both substance and methods, they exhibit a certain formal congruency that has captured the attention of both schools. The formal similarities between EBCT and ABCT invites a point-bypoint comparison, but the comparison itself dramatizes differences between the two views in a way that adds to the integrity and plausibility of the Austrian theory. In modern macroeconomic literature, the label EBCT is applied sometimes so broadly as to include New Keynesian as well as New Classical constructions and sometimes so narrowly as to preclude the very developments within the New Classical school that are most closely related to ABCT. So-called Real Business Cycle Theory, in which cyclical movements of macroeconomic variables are characterized by both market clearing and Pareto optimality, is sometimes designated as the only true equilibrium construction. The comparison of New Classical and Old Austrian theories is best facilitated by letting EBCT refer to those theories in which (a) individuals make the best use of the information available to them and (b) an informational deficiency temporarily masks the intementions of the monetary authority. As exposited by Robert Lucas (1981), Robert Barro (1981) and others, EBCT so conceived accounts for business cycles in terms of the actions of market participants confronted with what has come to be known as a signal-extraction problem. Difficulties in

On some computational aspects of equilibrium business cycle theory

This paper evaluates the accuracy of quadratic approximate methods in the context of a simple real business cycle model. The level of accuracy is found to be very high. On the face of the results reported here we are confident that the different computation methods proposed to date in this literature can be employed interchangeably.

Hayek and General Equilibrium Analysis

An unanticipated outcome of the renewed interest in Austrian economics is the claim that it shares important similarities with new-classical macroeconomics. This claim has been mounted in two related ways. First, Lucas [27] and Laidler [25] argue that the business cycle work of Hayek and Mises during the 1920s and 1930s is a precursor to contemporary equilibrium business cycle theory. Second, Colander and Guthrie [5] and Kantor [23] suggest that the rational expectations hypothesis resembles an Austrian theory of expectations. Together, these interpretations suggest a degree of correspondence between Austrian and new-classical macroeconomics not heretofore generally acknowledged by contemporary Austrian economists. Indeed, Austrians are usually at pains to emphasize a distinct Austrian point of view. Given the increased frequency of claims to the contrary, the rationale for a well-defined Austrian research program is called into question. The aim of this paper is to assess the correspondence between Hayek's business cycle studies and the equilibrium approach to business cycles favored by Lucas, Sargent, Wallace and others. Since the claim advanced by Lucas and Laidler refers only to Hayek's work in the 1920s and 1930s, I shall investigate their claim by restricting references to Hayek from the same period. In section II, I overview the equilibrium business cycle theory of newclassical macroeconomics, provide exegetical evidence pertaining to Hayek's early cycle studies, and discuss Hayek's notion of equilibrium. Section III probes the status of equilibrium theory in Hayek's early work and new-classical macroeconomics. In section IV, I summarize the main conclusions of the paper.

Rational Expectations in Stationary Linear Models

Linear time series models have come to dominate the macroeconomic literature on rational expectations and equilibrium business cycle theory. But the explicit solution of such models has generally required strong restrictions upon the exogenous process of stochastic shocks (e.g., temporal independence) as well as upon the values of various demand and supply elasticities. This paper exhibits a solution technique, the method of z-transforms, which does not require one to impose such restrictions. The value of this method is illustrated by applying it to completely characterize the symmetric, stationary, rational expectations equilibria of a naive linear model of land speculation. This approach also permits systematic study of the informationally asymmetric equilibria of the model. THIS PAPER develops a method for analyzing rational expectations (RE) equilibria in linear economic models. The methods I shall discuss usually enable one to determine whether or not a given model has a RE equilibrium and, if one exists, to exhibit an explicit expression for the stochastic process of equilibrium prices. The techniques apply to linear models driven by stationary processes of exogenous random shocks.

Equilibrium business cycle theory with centralized trading in some assets

This paper studies the consequences of information produced by economy-wide trading in assets for the equilibrium theory of the business cycle. The effects of unanticipated monetary disturbances are shown to depend on the nature of the other aggregate disturbances.