Real Business Cycle Model Research Articles

IDENTIFYING TECHNOLOGY SHOCKS AT THE BUSINESS CYCLE VIA SPECTRAL VARIANCE DECOMPOSITIONS

In this paper, we identify the technology shock at business cycle frequencies to improve the performance of structural vector autoregression models in small samples. To this end, we propose a new identification method based on the spectral decomposition of the variance, which targets the contributions of the shock in theoretical models. Results from a Monte-Carlo assessment show that the proposed method can deliver a precise estimate of the response of hours in small samples. We illustrate the application of our methodology using US data and a standard Real Business Cycle model. We find a positive response of hours in the short run following a non-significant, near-zero impact. This result is robust to a large set of credible parameterizations of the theoretical model.

Speculation-Driven Business Cycles

Speculation, in the spirit of Harrison and Kreps [1978], is introduced into a standard real business cycle model. Investors (speculators) hold heterogeneous beliefs about firm growth. Firm ownership, and thus, the firm’s discount factor varies with waves of optimism and leverage. These waves ripple into firm investments in hours. The firm’s discount discount factor links the equity premium and labor volatility puzzles. We obtain an upper bound to the amplification that can be generated by speculation for any model of beliefs -- a factor of 1.5. A calibration based on diagnostic beliefs amplifies hours volatility by a factor of 1.15 and produces a bubble component of 20 percent.

Macroprudential Policy in a Heterogeneous Environment-An Application of Agent-Based Approach in Systemic Risk Modelling.

Assessment of welfare effects of macroprudential policy seems the most important application of the Dynamic Stochastic General Equilibrium (DSGE) framework of macro-modelling. In particular, the DSGE-3D model, with three layers of default (3D), was developed and used by the European Systemic Risk Board and European Central Bank as a reference tool to formally model the financial cycle as well as to analyze effects of macroprudential policies. Despite the extreme importance of incorporating financial constraints in Real Business Cycle (RBC) models, the resulting DSGE-3D construct still embraces the representative agent idea, making serious analyses of diversity of economic entities impossible. In this paper, we present an alternative to DSGE modelling that seriously departs from the assumption of the representativeness of agents. Within an Agent Based Modelling (ABM) framework, we build an environment suitable for performing counterfactual simulations of the impact of macroprudential policy on the economy, financial system and society. We contribute to the existing literature by presenting an ABM model with broad insight into heterogeneity of agents. We show the stabilizing effects of macroprudential policies in the case of economic or financial distress.

A real business cycle model with money as a sunspot variable

A well-known criticism of the RBC model is that it cannot match the data on money. Due to the perfect flexibility of prices and the absence of frictions, any exogenous increase in the money supply will be fully offset by wage and price increases, implying that money is neutral even in the short run. However, beliefs that money is non-neutral could become a self-fulfilling prophesy. By using money as a sunspot variable in an RBC model, I successfully replicate many of the correlations in the data, even though money does not directly affect the economy’s fundamentals. This shows that models with flexible prices are not necessarily incompatible with the monetary data and offers support for the use of sunspot variables in macroeconomics.

The Macro and Asset Pricing Implications of Fluctuating Information Quality

I study the macroeconomic and asset pricing implications of variations in information quality in a real business cycle model. Learning and fluctuating information quality generate changes in the perception of macroeconomic outcomes, but do not modify the distribution of realized shocks. On the asset pricing side, the model generates stock market crashes that are disconnected from the fundamental shocks of the economy. Deterioration in the quality of information predicts spikes in macroeconomic and financial uncertainty. Consistent with the data, shocks to information quality forecast downside risk in macroeconomic aggregates like output and investment growth.

Risk Matters: Breaking Certainty Equivalence

In this paper we use the property that certainty equivalence, as implied by a first-order approximation to the solution of stochastic discrete-time models, breaks in its equivalent continuous-time version. We study the extent to which a first-order approximated solution built by perturbation methods accounts for risk. We show that risk matters economically in a real business cycle (RBC) model with habit formation and capital adjustment costs and that neglecting risk leads to substantial pricing errors. A first-order approximation in continuous time reduces pricing errors by 90 percent relative to the certainty equivalent linear solution.

Financial Shocks and the Relative Dynamics of Tangible and Intangible Investment: Evidence from the Euro Area

We develop an extended real business cycle (RBC) model with financially con-strained firms and non-pledgeable intangible capital. Based on a model-consistentseries for firms' borrowing conditions, we find, within a structural vector autoregres-sion (SVAR) framework, that, in response to an adverse financial shock, tangible in-vestment falls more than intangible investment. This positive co-movement betweentangible and intangible investment as well as the relative resilience of intangibleinvestment pose a challenge for the theoretical model. We show that investment-specific adjustment costs help in reconciling the model with the observed empiricalevidence. The estimation of the theoretical model using a Bayesian limited infor-mation approach yields support for the presence of much larger adjustment costsfor intangible investment than for tangible investment.

Uncertainty Shocks and Business Cycle Research

We review the literature on uncertainty shocks and business cycle research. First, we motivate the study of uncertainty shocks by documenting the presence of time-variation in the volatility of macroeconomic time series. Second, we enumerate the mechanisms that researchers have postulated to link uncertainty shocks and business cycles. Third, we outline how we can specify uncertainty shocks. Fourth, we postulate a real business cycle model augmented with financial frictions and uncertainty shocks. Fifth, we use the model to illustrate our previous discussions and to show how uncertainty shocks can be expansionary. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Pollution and Labor Market Search Externalities Over the Business Cycle

We study the relationship between unemployment, environmental policy, and business cycles. We develop a dynamic stochastic general equilibrium real business cycle model that includes both a pollution externality and congestion externalities from labor market search frictions, which generate unemployment. We consider two policies to address the market failures: an emissions tax and a tax or subsidy on job creation. With both policies present, the efficient outcome can be achieved. When one policy is constrained or absent, we solve for the second best. The absence of a vacancy policy to address the congestion externalities substantially affects the value of the emissions tax, both in steady state and over the business cycle.

Calibrating Agent-Based Models with Linear Regressions

By recasting indirect inference estimation as a prediction rather than a minimization and by using regularized regressions, we can bypass the three major problems of estimation: selecting the summary statistics, defining the distance function and minimizing it numerically. By substituting regression with classification we can extend this approach to model selection as well. We present three examples: a statistical fit, the parametrization of a simple real business cycle model and heuristics selection in a fishery agent-based model. The outcome is a method that automatically chooses summary statistics, weighs them and use them to parametrize models without running any direct minimization.

Estimates of the Natural Rate of Interest for Russia: Is Navigating by the Stars Useful?

We estimate the natural rate of interest for Russia in the short term and long term using three definitions of the rate and discuss the possible implications of the results for monetary policy. To start with, we consider partial equilibrium (under no-arbitrage condition), which is presented in the papers on estimating the natural rate. The estimates turn out to be extremely sensitive to assumptions about model parameters. The estimates based on the uncovered interest rate parity, though dependent only on observable (market) variables, impose an additional strong assumption of the path of the future equilibrium exchange rate. We supplement these calculations with calculations in panel data (for long-term equilibrium) and using semi-structural methods (for current equilibrium). To get estimates according to the strict definition of the natural rate we estimate a real business cycle model of the resource-based economy with investments using Russian data. All the estimates are highly uncertain. Taking into account the latter, the central bank should use robust monetary policy rules and avoid communicating the natural rate at least until there has been a sufficient history of business cycles in Russia.

Identifying noise shocks

We study identifying restrictions that allow news and noise shocks to be recovered empirically within a Bayesian structural VARMA framework. In population, the identification scheme we consider exactly recovers news and noise shocks. Monte Carlo evidence further demonstrates its excellent performance, as it recovers the key features of the postulated data-generation process—the real-business cycle model of Barsky and Sims (2011) augmented with noise shocks about future total factor productivity (TFP)—with great precision. In an empirical application, evidence suggests that TFP noise shocks play a minor role in macroeconomic fluctuations.

Intersectoral linkages, diverse information, and aggregate dynamics

What are the aggregate consequences of information frictions? We address this question in a multi-sector real business cycle model in which firms learn from market-based information. Theoretically, we present two distinct cases in which the aggregate effects of incomplete information completely disappear: either (i) market-based information reveals sector-level optimal actions, or (ii) market-based information reveals aggregate conditions in the economy. When the model is calibrated to United States' sectoral data, both conditions hold almost exactly and incomplete information has a negligible effect on aggregate dynamics.

Endogenous Tradability, International Relative Prices, and the International Transmission of Business Cycles

This paper propose a two-country, dynamic, stochastic, general equilibrium (DSGE) model with endogenous tradability, product differentiation, variously determined physical capital, and an elastic labor supply to explore the propagation of business cycles across countries. The model successfully addresses international relative price dynamics (its appreciation with positive home productivity shock, called the ‘Harrod-Balassa-Samuelson Effect’) through the entry of producers and their cut-off productivities of exporting. The use of endogenous physical capital in the model induces a more realistic framework since the simulated model is compared to the U.S. investment data that covers spending on capital equipment, structures and inventories for producers’ entry and exit dynamics. Building the model with endogenous capital and elastic labor supply weakens the volatility of investment compared to conventional international real business cycle (IRBC) models. The model also accounts for several features of the data, such as the volatility of aggregate variables and their correlations with GDP.

Aggregate Hours and Local Projections with Long-Run Restrictions

I extend the local projections method to identify structural shocks using long-run restrictions. I show that the proposed estimator is substantially more robust than structural VARs (SVARs) to both the choice of lag length and the order of integration of the endogenous variables using data from a standard real business cycle (RBC) model. Benchmark simulations show that the proposed estimator can yield substantial reductions in both the bias and mean squared error of estimated impulse response functions relative to SVARs, particularly at short forecast horizons. In all cases, the proposed estimator correctly estimates the direction of the contemporaneous response and the shape of the full impulse response function, and can eliminate virtually all of the bias for some specification choices. Using my proposed estimator and data obtained from the Bureau of Labor Statistics, I then estimate the response of aggregate labor hours to productivity shocks. In contrast to much of the evidence based on SVARs, I find that labor hours rise in response to positive productivity shocks and subsequently follow a hump shaped profile. This result is robust to a number of specification choices and provides new evidence in support of the standard RBC model.

Emissions Pricing Policies and Business Cycles: Fixed vs. Variable Tax Regimes

AbstractAs by‐products, emissions follow economic fluctuations. Ignoring this fact in environmental policies can lead to unexpected emissions fluctuations and an increase in intervention costs. Using a real business cycle model, we compare two policies: a fixed tax policy where the price is constant over time and a variable tax regime where the tax rate is set at the beginning of each period. We find that while both programs result in lower emissions, a variable tax regime is preferable since first, it can ensure that the maximum welfare is always achieved, and second, it is more effective in stabilising emissions.

Endogenous borrowing constraints and stagnation in Latin America

The Latin American debt crisis of the 1980’s had a major and long-lasting effect on per-capita consumption: its level in 2005 was not that different from that in 1980. This paper studies the long stagnation in per-capita consumption that followed the crisis, and its relationship with recessions and sovereign risk, using a small open economy real business cycle model with complete markets, endogenous borrowing limits (limited commitment), endogenous capital accumulation, and domestic productivity and international interest rate shocks. I find that the model does an excellent job at explaining the observed behavior of per-capita consumption and that both the productivity and international interest rate shocks are important. Furthermore, I show that the participation constraint in this kind of representative agent model can bind not only in good times but also in prolonged bad times.

Noisy information, risk sharing, and international business cycles

AbstractWe introduce a noisy information structure into an otherwise standard international real business cycle model with two countries. When domestic firms observe current foreign technology with some noise, predictions of the model on international correlation can be very different from those of a standard perfect information model. We show that the model can explain: (a) positive output correlation both in complete and incomplete market models, (b) consumption correlation smaller than output correlation with an introduction of information‐constrained consumers, and (c) observation of both positive and negative productivity–hours correlation in two countries.

TECHNOLOGY SHOCKS AND HOURS WORKED: A CROSS-COUNTRY ANALYSIS

We reassess the evidence for (or against) a key implication of the basic real business cycle model: that aggregate hours worked increase in response to a positive technology shock. Two novel aspects are the scope (14 OECD countries) and the inclusion of data on both labor supply margins to analyze the key margin of adjustment in aggregate hours. The short-run response of aggregate hours to a positive technology shock is remarkably similar across countries, with an impact fall in 13 out of 14 countries. In contrast, its decomposition into intensive and extensive labor supply margins reveals substantial heterogeneity in labor market dynamics across OECD countries. For instance, movements in the intensive margin are the dominant channel of adjustment in aggregate hours in 6 out of 14 countries of our sample, including France and Japan.

What is the Social Trade-off of Securitization? A Tale of Financial Innovation

This paper conducts a macroeconomic welfare analysis of securitization in a real business cycle model with a banking sector. I model securitization as an optional interbank funding channel that credibly reduces the diversion ability on borrowed funds and increases operation costs on loan assets. In effect, securitization allows banks to increase the asset size while sacrificing the rate of return per unit of assets. I demonstrate that the availability of securitization increases the resilience against banking sector breakdowns and increases the size of credit booms associated with a subsequent breakdown. The economy with securitization option experiences less frequent financial recessions but once a financial recession occurs, it is likely to be more severe. In the presence of the savings glut externality where households do not internalize the effects of their savings behavior on the banking sector, the financial innovation of increasing the profitability of securitization can exacerbate an over-investment in production. Therefore, under highly developed securitization, regulation may be needed to balance the social gains and the social losses from securitization. In a calibrated version of the model, I illustrate that an optimal regulation on the incentives of securitization can make the availability of securitization socially beneficial.