# 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.