Business Cycles in International Historical Perspective

TLDR: In this article, the authors turn business cycle theories loose on perhaps the greatest macroeconomic laboratory and find empirical evidence for and against these various approaches, which is consistent with rigorous microfoundations and rational expectations.

Abstract: Business cycle models seek to answer the question of why economies go through cycles of recession and recovery, or boom and bust. Any theory of the business cycle makes two sorts of claims: what shocks are most important in disturbing the economy and what economic structure is necessary for propagating these shocks. For example, one common explanation of business cycles begins with monetary shocks and then seeks to explain why monetary shocks are not purely neutral, as neoclassical theory would have it, and instead have real effects, at least in the short term. Early models in this vein were often implicitly or explicitly based on the proposition that markets do not clear continuously. Early equilibrium “real business cycle” theories instead emphasized the importance of real shocks, especially to technology, which may cause socially efficient fluctuations even when markets are always in equilibrium. More recent models have attempted to marry the equilibrium approach to macroeconomics with the substantive Keynesian ideas that money is not neutral and that economic fluctuations are costly. New Keynesian theories of the business cycle admit the possibility of a number of economic shocks, including monetary and technology shocks, but then focus on explaining how nominal price rigidities within the economy can turn these shocks into recessions or booms. Other models show that business cycles driven by Keynesian “animal spirits” are consistent with rigorous microfoundations and rational expectations. Seeking empirical evidence for and against these various approaches, we turn business cycle theories loose on perhaps the greatest macroeconomic laboratory