Real Business Cycle Theory: A Gag?
Imagine someone says to you, "I have developed a satisfactory explanation of why sunspots sometimes ebb and sometimes flow at various times."
"OK, that's great. And it is?"
"Well, see, I looked at ten variables. None of them explain the sunspot cycle."
"OK...."
"So what explains the sunspot cycle is residuals! The things that are left out of my model!"
I would hope you would dismiss this fellow as a jokester. His model has totally failed to predict sunspots, and what accounts for them is not in his model at all. But when I began reading up on real business cycle theory, I began encountering what seemed to me to be just this sort of explanation for "fluctuations." Surely, I thought, I must not have adequately understood RBC yet: could any serious scholar really advance such a notion? I needed to read more!
But as I did, I realized that other serious thinkers have pointed out just this ridiculous aspect of RBC. So then what explains the persistence of RBC theorizing? Simon Wren-Lewis explains:
"One explanation [for RBC's popularity] is ideological. The commonsense view of the business cycle, and the need to in some sense smooth this cycle, is that it involves a market failure that requires the intervention of a state institution in some form. If your ideological view is to deny market failure where possible, and therefore minimise a role for the state, then it is natural enough (although hardly scientific) to ignore inconvenient facts. For the record I think those on the left are as capable of ignoring inconvenient facts: however there is not a left wing equivalent of RBC theory which plays a central role in mainstream macroeconomics"
I think Wren-Lewis is a little inaccurate here: Austrians, after all, think there really is a cycle, and that policy should be changed to fix this problem, but generally have recommend more free marketness, not less. I suspect that the ideology that drives RBC theorizing is commitment to the status quo, and the continued domination of the financial industry over all of our lives.
"OK, that's great. And it is?"
"Well, see, I looked at ten variables. None of them explain the sunspot cycle."
"OK...."
"So what explains the sunspot cycle is residuals! The things that are left out of my model!"
I would hope you would dismiss this fellow as a jokester. His model has totally failed to predict sunspots, and what accounts for them is not in his model at all. But when I began reading up on real business cycle theory, I began encountering what seemed to me to be just this sort of explanation for "fluctuations." Surely, I thought, I must not have adequately understood RBC yet: could any serious scholar really advance such a notion? I needed to read more!
But as I did, I realized that other serious thinkers have pointed out just this ridiculous aspect of RBC. So then what explains the persistence of RBC theorizing? Simon Wren-Lewis explains:
"One explanation [for RBC's popularity] is ideological. The commonsense view of the business cycle, and the need to in some sense smooth this cycle, is that it involves a market failure that requires the intervention of a state institution in some form. If your ideological view is to deny market failure where possible, and therefore minimise a role for the state, then it is natural enough (although hardly scientific) to ignore inconvenient facts. For the record I think those on the left are as capable of ignoring inconvenient facts: however there is not a left wing equivalent of RBC theory which plays a central role in mainstream macroeconomics"
I think Wren-Lewis is a little inaccurate here: Austrians, after all, think there really is a cycle, and that policy should be changed to fix this problem, but generally have recommend more free marketness, not less. I suspect that the ideology that drives RBC theorizing is commitment to the status quo, and the continued domination of the financial industry over all of our lives.
Hahaha. I want to do this on my econometrics paper and see what my professor thinks.
ReplyDeleteIt's the residuals!
Thanks for delving into this, Gene. I had problems with RBC when I first read about it, but I couldn't quite put my finger on it. Obviously, I had my own beliefs (egads!) and biases going into it, but you've really hit the nail on the head here.
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