hnl h nd th bn l Mrtn Ehnb trll h rrh n rn h trt Kdlnd nd rn h fd rtt (19 r bl t ntrt nd n n th rltv - nlz pl nrl lbr dl f prtn f dffrnt h t th US n n hh thnl h rt n tvt r pprntl bl t nt fr all tpt h trdtnl v hrd b Mntrt vrblt n th ptr US ldn n nd Knn l tht xn h Kdlnd nd rtt r nn (195 t rt dnd h th ndd b nd thr rrhr hd tht vrnt f hft n ntr pl r ntrl pl th b C dl r l bl t t th bn l Irrptv f thr nt fr th rltv vltlt f r- thr dffrn dhrnt f th trdtnl t vrbl h rl nptn n- v hr th n l f trvn t vtnt nd pr pt hr rd Gvn ndrtnd th hn b hh n- th fndn th nd fr n dt thr tr pl fft rt n tv- f ntr nd fl r f ntblt t h t h l prn rhp h rptd l h f th lt 15 nn th nt f rrh d- r nd th lrtn p f thnl- vtd t th tp h dlnd prp- l hn hv ld t brdn n th tl nn tht hn n rt dnd t rprnl C thr hv n- r th n r f bn l h rtd rt dl f ntrvr In prt th dln f th trdtnl v ndd th ntrvr rvlv rnd th btntv th dvlpnt f rp f dl ll- l d b C nlt At th tvl nn l n Cl (C t thr h bn ndrbl ntrvr thr In hrp ntrt t th trdtnl bt th ft tht C nlt ddr th v C thr t xpln th b- dt n hhl tlzd nrl lbr n l n tht btrt fr ntr dl ll thrtl dl C ndrtn ntrl Ardn t th dl btrt fr dffrnt pt f rl- thr xn h t rt p- pl h thnl h r th rtl Mrtn Ehnb prfr f n t r f pl t ptr US bn rthtrn Unvrt nd nr nltnt t l Whl C thrt d nt l tht th drl rv n f Ch. h thr thn Cr rnd, rn Chrtn, Sr ntr pl nhrntl ntrl th d bl, h Srnt, nd Mr Wtn fr blv tht C dl n ptr th l- thr dv nd hlp. h rtl bd pn nt ftr f ptr US bn l "l bn l thr: d r h?," frthn, rnl f En n nd tht nrprtn ntr h nt Cntrl. th nl 4 ECONOMIC PERSPECTIVES ity. According to this criticism, all theoretical the strong conclusions which mark the RBC models, including RBC models, are wrong. literature depend critically on this assumption. While I agree that theoretical models are nec- Absent this crucial assumption, the sharp infer- essarily false, this criticism overlooks the real ences which RBC analysts draw regarding the usefulness of many theoretical models. What importance of technology shocks are not sup- is striking about RBC models is their apparent ported by the data. I conclude that although ability to account for important features of the technology shocks almost certainly play some business cycle, despite their obvious simplic- role in generating the business cycle, there is ity. simply an enormous amount of uncertainty This article assesses the quality of the about just what percentage of aggregate fluc- empirical evidence provided by RBC analysts tuations they actually do account for. The to support their substantive claims regarding answer could be 70 percent as Kydland and the cyclical role of technology shocks. I argue Prescott (1989) claim, but it could also be 5 that the data and the methods used by these percent or even 200 percent. analysts are, in fact, almost completely unin- formative about the role of technology shocks A prttpl l n Cl Mdl in generating aggregate fluctuations in U.S. RBC models share the view that aggregate output. In addition I argue that their conclu- economic time series correspond to the evolu- sions are not robust either to changes in the tion of a dynamic stochastic equilibrium in sample period investigated or to small pertur- which optimizing firms, labor suppliers, and bations in their models. For these reasons, I consumers interact in stochastic environments. conclude that the empirical results in the RBC The basic sources of uncertainty in agents' literature do not constitute a convincing chal- environments constitute the impulses to the lenge to the traditional view regarding the business cycle. The type of impulse which has cyclical importance of aggregate demand received the most attention are shocks to the shocks. aggregate production technology which affect The remainder of this article is organized both the marginal productivity of labor and the as follows. The second section summarizes marginal productivity of capital. the evidence used by RBC analysts to support Under these circumstances the time series the claim that technology shocks account for on hours worked and the return to working most of the variability in aggregate U.S. out- correspond to the intersection of a stochastic put. I then argue that the empirical approach labor demand curve with a fixed labor supply used by RBC analysts, commonly referred to curve.' As long as agents are willing to substi- as "calibration," does not provide useful input tute labor over time, an increase in the time t into the problem of deciding which impulses marginal productivity of labor ought to gener- have been the major sources of postwar fluc- ate an increase in per capita hours worked, real tuations in output. The third section analyzes wages, and output. Given a temporary in- the sensitivity of RBC conclusions to simple crease in aggregate output and a desire on perturbations in the model as well as to agents' part to smooth consumption over time, changes in the sample period investigated. these theories also predict a large positive Finally, the fourth section contains some con- increase in investment as well as a positive but cluding remarks. smaller increase in consumption. hnl h nd rt In order to assess the quantitative implica- tpt flttn tions of RBC theories it is useful to focus our This section reviews the basic empirical attention on one widely used RBC model—the results presented by RBC analysts to support Indivisible Labor Model associated with Gary their contention that aggregate technology Hansen (1985) and Richard Rogerson (1988). shocks account for a large percentage of ag- The basic setup of that model can be described gregate U.S. output fluctuations. In presenting as follows. The economy is populated by a these results I abandon the RBC analysts' finite number of infinitely lived, identical, counterfactual assumption that the value of the perfectly competitive individuals. Each per- model's structural parameters are actually son is endowed with T units of time which can known, rather than estimated. I then show that be allocated towards work or leisure. 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