Real Business Cycle Theory: What Have We Learned?

Abstract

Real business-cycle theory is the application of general equilibrium theory to the quantitative analysis of business-cycle fluctuations. The theory is real in the sense that there really is something there. In this review article I document that in applying established theory to quantitatively address business-cycle questions, a lot has been learned. We learned that business cycles are not deviations from this established theory, but rather are just what this theory predicts. In particular, we learned that business cycles are induced by highly persistent changes in those factors that determine the steady-state level of the deterministic growth model. Non persistent shocks do not induce fluctuations of the business-cycle variety. In this article I also discuss some methodological issues concerning judging and testing business cycle models.