Real business cycle theory is not dead

Stephanie Schmitt-Grohe and Martin Uribe report (ungated here):

In this paper, we perform a structural Bayesian estimation of the
contribution of anticipated shocks to business cycles in the postwar
United States. Our theoretical framework is a real-business-cycle model
augmented with four real rigidities: investment adjustment costs,
variable capacity utilization, habit formation in consumption, and
habit formation in leisure. Business cycles are assumed to be driven by
permanent and stationary neutral productivity shocks, permanent
investment-specific shocks, and government spending shocks. Each of
these shocks is buffeted by four types of structural innovations:
unanticipated innovations and innovations anticipated one, two, and
three quarters in advance. We find that anticipated shocks account for
more than two thirds of predicted aggregate fluctuations. This result
is robust to estimating a variant of the model featuring a parametric
wealth elasticity of labor supply.

Jerry-rigged, yes.  But the principle of Occam’s Razor isn’t as strong as many people think.  If the mechanisms governing real world outcomes actually are that complicated, and if the simpler theories have failed, than jerry-rigging it is.  And, as Christina Romer has pointed out, deflationary money shocks are still bad for output and employment, which means the theory has at least an extra branch.


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