Must-Read: Noah Smith: Real Business Cycle Theory as Gaslighting

Must-Read: Noah Smith: Real Business Cycle Theory as Gaslighting: “The basic 1982 Nobel-winning RBC model…

…a complete-markets, representative-agent theory of business cycles where productivity shocks, leisure preference shocks, and/or government policy distortions drive business cycles–has never been very good at matching the data…. Simple patches… didn’t really improve the fit…. The model isn’t very robust to small frictions, either. And one of the main data techniques used… the Hodrick-Prescott filter… [is] very dodgy. Furthermore… Chris Sims showed that the main policy implication of RBC–that monetary policy can’t be used to stabilize the real economy–doesn’t hold up…. [But] RBC fans maintain that RBC is the basic workhorse business cycle model….

Ed Prescott and Ellen McGrattan released a paper claiming that if you just patch basic RBC up with one additional type of capital, it fits the data just fine. As if this were the only empirical problem with RBC, and as if this new type of capital has empirical support!… Gomme, Ravikumar and Rupert… refers to RBC as “the standard business-cycle model”. As if anyone actually uses it as such!… Valerie Ramey says: “Of course, [the] view [that monetary policy is not an important factor in business cycles] was significantly strengthened by Kydland and Prescott’s (1982) seminal demonstration that business cycles could be explained with technology shocks.” As if any such thing was actually demonstrated!…

This strikes me as a form of gaslighting–RBC fans just blithely repeat, again and again, that the 1982 RBC model was a great empirical success…. Why do RBC fans keep on blithely repeating that RBC was a huge success, needs only minor patches, and is now the standard model?… If RBC was refuted [by 1980-84]… it means that the Lucas/Prescott/Sargent revolution looks just a little bit more like a wrong turn…. Or maybe RBC represents a form of wish fulfillment. If RBC is right, stabilization policy–which, if you believe Hayek, just might be the thin edge of a socialist wedge–is just a “rain dance”…. It could also be a sort of high-level debating tactic…. Anyway, whatever the reason, it’s kind of entertaining to watch…