Real Business Cycle Theory - Politics Forum.org | PoFo

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By wat0n
#13617768
Real business cycle theory (RBC theory) are a class of macroeconomic models in which business cycle fluctuations to a large extent can be accounted for by real (in contrast to nominal) shocks. Unlike other leading theories of the business cycle, RBC theory sees recessions and periods of economic growth as the efficient response to exogenous changes in the real economic environment. That is, the level of national output necessarily maximizes expected utility, and government should therefore concentrate on the long-run structural policy changes and not intervene through discretionary fiscal or monetary policy designed to actively smooth out economic short-term fluctuations.

According to RBC theory, business cycles are therefore "real" in that they do not represent a failure of markets to clear but rather reflect the most efficient possible operation of the economy, given the structure of the economy. RBC theory differs in this way from other theories of the business cycle such as Keynesian economics and Monetarism that see recessions as the failure of some market to clear.

RBC theory is associated with freshwater economics (the Chicago school of economics in the neoclassical tradition).


http://en.wikipedia.org/wiki/Real_business_cycle_theory

Do libertarians on this forum agree with this explanation for the business cycle? If so, which theory is better, the Austrian Business Cycle Theory or this one?
By Kman
#13617883
wat0n wrote:Do libertarians on this forum agree with this explanation for the business cycle? If so, which theory is better, the Austrian Business Cycle Theory or this one?


What is their theory exactly? that the housing bubble in the US was a good thing? because that is how it sounds to me when im reading the text you linked.
By eugenekop
#13618754
I am not an expert on business cycle theory by a long shot, but the Austrian business cycle theory blames the Fed and other government intervention for mal-investments, the correction of which happens in depressions. However according to this theory business cycles will still occur even without government intervention, but they will be shorter and much less severe.

Now, what makes the Austrian business cycle theory similar to the one you brought here is that both contend that depressions cleanse the market from mal-investments, and that government intervention only stops this important process.
By wat0n
#13621102
What is their theory exactly? that the housing bubble in the US was a good thing? because that is how it sounds to me when im reading the text you linked.


The theory is that the business cycle is caused by real shocks which change wages and interest rates and that the fluctuations (both booms and busts) are an efficient answer from the economy. That is, even if the economy has complete, flexible and perfectly competitive free markets a recession can be the most efficient (i.e. best) answer to the real and random shocks that affect the economy. In these conditions, employment decreases are totally voluntary (people work less because they earn less and thus they opt to leave the job market) and any attempts to stabilize the economy cause problems (for instance, monetary policy only affects the rate of inflation and has no short-run effects on GDP because, well, companies change their prices automatically).

While IMHO the intuition is totally wrong (if this theory is true, then there should be no cyclical unemployment - let's keep in mind that an unemployed person is a person who is looking for a job but can't find one - and thus the Great Depression would be a "Great Vacation", as Paul Krugman put it) it has empirical support (e.g. if I'm not mistaken these models do well when predicting Chile's economic fluctuations), something that can't be said of the Austrian Business Cycle Theory if I'm not mistaken.
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By TropicalK
#13621356
In the 1930's, there was an oversupply of food.

In your household, if you bought a lot of groceries because there was a stock-up deal, then you could put off buying groceries for a few weeks. Same thing economy-wide, people should take there vacations when the demand for their labor is less.

Currently, there is an oversupply of houses, no need to build anymore. An FDR would propose building houses, then smashing them with tanks to keep prices high and out of reach of common citizens.

I hear a lot from many people (especially Austrian economists) that there should be no cyclical unemployment. I do not understand where this conclusion comes from. I can certainly imagine a scenario where there are a limited amount of opportunities for work. In fact, it could be optimal for a sizable group of people to be on permanent vacation.
By Michaeluj
#13622188
It seems that, while there would be ups and downs, they shouldn't be classified as anything remotely as bad a recession. Whether a collection of these causes such a downturn is still, to me, an unconvincing argument without examples and data.
By Kman
#13623372
wat0n wrote:In these conditions, employment decreases are totally voluntary


That doesnt sound correct, plenty of people who like their jobs get fired during recessions.

wat0n wrote:(people work less because they earn less and thus they opt to leave the job market)


People still have bills to pay and mouthes to feed though (a single mother just scraping by on her paycheck will have to work 30% more if her wage only buys her 70% of normal), I dont think the correlation as this theory puts it forth is all that straight forward.

wat0n wrote:it has empirical support (e.g. if I'm not mistaken these models do well when predicting Chile's economic fluctuations), something that can't be said of the Austrian Business Cycle Theory if I'm not mistaken.


I dont get the impression that austrian economists even try to predict daily ups and downs in the economy because that requires one to be able to be a mind reader in order to get an accurate prediction rate on minor short term behavior.

Now you can probably setup a model that can take guesses at the future but that is all that these models are, they are guesses and sometimes they are wrong, like they were in 2008 where none of these fancy models predicted an imminent collapse like most austrian school economists did (not to mention other economic fluctuations that austrian school economists predicted like the Great Depression, the stagflation in the 70's, the Nasdaq bubble and the housing bubble in the 2000's).

From wikipedia wrote:It is important to note the main assumption in RBC theory is that individuals and firms respond optimally all the time. In other words, if the government came along and forced people to work more or less than they would have otherwise, it would most likely make people unhappy. It follows that business cycles exhibited in an economy are chosen in preference to no business cycles at all.


Now I know for sure that I dont agree with it, human beings dont act optimally all the time, they are just miniscule cogs with limited information in a huge machinery and they do not act optimally all the time, you can see this in all the various economic bubbles that have formed in the past like the Tulip bubble in Holland in the 17th century, the South Sea bubble in the UK and the Mississippi Company bubble in France in the early 18th century, the Nasdaq internet bubble, the housing bubble etc...etc...etc... all these events were irrational and foolish from an economic perspective and yet people still created these economic catastrophes that made alot of people very poor and wasted alot of economic resources.

This theory apparently believes that people choose on their own accord to start these fluctuations meaning it misses the underlying causes for most of this irrational behavior (which is almost always price signals getting jumbled by money creation from a central authority/bank).

Like the wikipedia states this theory shares alot in common with Milton Friedman and his belief that capitalism IE human beings acting in their own interest is some flawless system that always operates optimally.

TropicalK wrote:I hear a lot from many people (especially Austrian economists) that there should be no cyclical unemployment. I do not understand where this conclusion comes from.


Mises believed that if the government didnt create all these disturbances and misallocations of resources in the economy then there would always be capital goods in queue ready to be transformed into tradeable goods if the human labor was available to operate them.

TropicalK wrote:In fact, it could be optimal for a sizable group of people to be on permanent vacation.


Why is that? wouldnt it be more optimal for everyone to work less hours per week instead of having 1 group of the population working and another group being on vacation?
By eugenekop
#13623494
This theory apparently believes that people choose on their own accord to start these fluctuations meaning it misses the underlying causes for most of this irrational behavior (which is almost always price signals getting jumbled by money creation from a central authority/bank).

Like the wikipedia states this theory shares alot in common with Milton Friedman and his belief that capitalism IE human beings acting in their own interest is some flawless system that always operates optimally.


But if according to you people act irrationally a lot of the time, it means that they will make mistakes regardless of the operations of the central bank/authority. So bubbles will always occur. Regardless, I don't think Milton Friedman thought that the market is perfect, only that the government intervention makes it worse.
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By TropicalK
#13624356
TropicalK wrote:
I hear a lot from many people (especially Austrian economists) that there should be no cyclical unemployment. I do not understand where this conclusion comes from.


Mises believed that if the government didnt create all these disturbances and misallocations of resources in the economy then there would always be capital goods in queue ready to be transformed into tradeable goods if the human labor was available to operate them.

Why should I believe this to be the case. In my personal life, I've been in situations where I simply had nothing to do. I was soo bored that I just went to sleep. Why can't the economy at large be devoid of purposeful labor opportunities.

TropicalK wrote:
In fact, it could be optimal for a sizable group of people to be on permanent vacation.


Why is that? wouldnt it be more optimal for everyone to work less hours per week instead of having 1 group of the population working and another group being on vacation?

Not necessarily. Training people costs time and money. Let's take an example. It takes one month to train someone at a movie theater.
The owner has two options. He can hire one person to work 10 hours a day and pay him $10 an hour after training him for one month (with pay.)
He can hire two people, each working five hours a day, but since they each work less, the training period would take twice as long.

It is less costly to hire one person to work a lot of hours. This is true society-wide as well. When you consider specialization and weeding out top performers, this effect becomes even more pronounced. Via utilitarianism, the bizarre conclusion would be that the hardest working and smartest should enjoy less free time and less happiness than the more useless segment of the population.
By wat0n
#13624745
That doesnt sound correct, plenty of people who like their jobs get fired during recessions.


Exactly, that's why Keynesian and new-Keynesian economists don't like RBC Theory.
By Kman
#13624905
wat0n wrote:Exactly, that's why Keynesian and new-Keynesian economists don't like RBC Theory.


Well its not like Keynesians are much better with their belief that government investment can create economic prosperity.
By KPres
#13628796
Not a lot of discussion on Real Business Cycle theory here, which is unfortunate, because I'm interested and don't think I understand fully. I know Robert Prescott won a nobel prize for it in 2004, though, so it seems that it has academic legitimacy. Can anybody explain what it's relationship to the Efficient Market Hypothesis is? They seem to come from similar schools of thought.


I hear a lot from many people (especially Austrian economists) that there should be no cyclical unemployment. I do not understand where this conclusion comes from. I can certainly imagine a scenario where there are a limited amount of opportunities for work. In fact, it could be optimal for a sizable group of people to be on permanent vacation.


Theoretically, competition from the unemployed will drive down the cost of labor to the point that everybody would have a job. If there's a limited amount of work to be done, then people's preference for leisure would begin to exceed the value of their labor, and they'd work fewer hours until everybody would once again have a job. Thus no persistent cyclical unemployment.
By KPres
#13628802
That doesnt sound correct, plenty of people who like their jobs get fired during recessions.

Exactly, that's why Keynesian and new-Keynesian economists don't like RBC Theory.


That's not really what the theory is saying. The idea is that unemployment is voluntary. That doesn't necessarily mean people "like" it, it just means that that they see it as the best option available. For example, I don't "like" having to work, period. I just prefer it to starving. Thus, my employment is voluntary.
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By Paradigm
#13628872
I think the point they're getting at with the "voluntary" unemployment idea is that when the market adjusts to certain shocks, the wage level drops. The idea is that there is an efficient wage level at which full employment could be reached, but such wages are too low for people to accept, therefore they "choose" to be unemployed, rather than accept the efficient wage level. For this reason, RBC theorists tend to oppose minimum wage laws.
By Kman
#13628901
So do these RBCT believers think that the government should manipulate the money supply and interest rates?

I couldnt really find any info on that in the wikipedia article, their theory as to what causes depressions seems to be that ''they are just natural, like the sun rising every morning''.

KPres wrote:That's not really what the theory is saying. The idea is that unemployment is voluntary. That doesn't necessarily mean people "like" it, it just means that that they see it as the best option available. For example, I don't "like" having to work, period. I just prefer it to starving. Thus, my employment is voluntary.


Unemployment is only voluntary if you can find someone to supply you with food (or you have large savings), otherwise nature makes unemployment very much involuntary (unless you prefer the alternative which is starvation).

I find the theory in general a little weird in general, so people are just supposed to go ''well there is a depression so I cant buy much with my wages so I will just stop working?'' and this is supposed to set in motion some sort of chain reaction where everyone stops working because they cant live as luxuriously as before with their wages?
By wat0n
#13629173
That's not really what the theory is saying. The idea is that unemployment is voluntary. That doesn't necessarily mean people "like" it, it just means that that they see it as the best option available. For example, I don't "like" having to work, period. I just prefer it to starving. Thus, my employment is voluntary.


Uneployment is voluntary in the sense that some people willingly give up their jobs and leave the job market because wages decreased. However, in reality you see people who get fired and/or who want to work, but cannot find a job due to the economic cycle.

So do these RBCT believers think that the government should manipulate the money supply and interest rates?


No.

I couldnt really find any info on that in the wikipedia article, their theory as to what causes depressions seems to be that ''they are just natural, like the sun rising every morning''.


Yes, it's something like that.
#14993793
I am not a specialist on business cycle hypothesis by far, however, the Austrian business cycle hypothesis accuses the Fed and other government mediation of mal-ventures, the rectification of which occurs in sorrows. Anyway as per this hypothesis business cycles will, in any case, happen even without government intercession, however, they will be shorter and significantly less extreme.

Presently, what makes the Austrian business cycle hypothesis like the one you brought here is that both battle that sorrows purify the market from mal-ventures, and that administration.

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