Real business cycles — nonsense on stilts

16 Jun, 2021 at 10:50 | Posted in Economics | 2 Comments

rbcThey try to explain business cycles solely as problems of information, such as asymmetries and imperfections in the information agents have. Those assumptions are just as arbitrary as the institutional rigidities and inertia they find objectionable in other theories of business fluctuations … I try to point out how incapable the new equilibrium business cycles models are of explaining the most obvious observed facts of cyclical fluctuations … I don’t think that models so far from realistic description should be taken seriously as a guide to policy … I don’t think that there is a way to write down any model which at one hand respects the possible diversity of agents in taste, circumstances, and so on, and at the other hand also grounds behavior rigorously in utility maximization and which has any substantive content to it.

James Tobin

Real business cycle theory (RBC) basically says that economic cycles are caused by technology-induced changes in productivity. It says that employment goes up or down because people choose to work more when productivity is high and less when it’s low. This is of course nothing but pure nonsense — and how on earth those guys that promoted this theory (Thomas Sargent et consortes) could be awarded The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel is really beyond comprehension.

In yours truly’s History of Economic Theories (4th ed, 2007, p. 405) it was concluded that

the problem is that it has turned out to be very difficult to empirically verify the theory’s view on economic fluctuations as being effects of rational actors’ optimal intertemporal choices … Empirical studies have not been able to corroborate the assumption of the sensitivity of labour supply to changes in intertemporal relative prices. Most studies rather points to expected changes in real wages having only rather little influence on the supply of labour.

Rigorous models lacking relevance is not to be taken seriously. Or as a famous British economist once  had it:

Why it is better to be roughly right than precisely wrong | Real-World  Economics Review Blog


  1. Lars,
    Is there an English edition of your book “History of Economic Theories”?
    It is interesting to note that the title of the book from which the Tobin piece comes from is “Conversations With Economists: New Classical Economists and Opponents Speak Out on the Current Controversy in Macroeconomics”. Published in 1988.
    The word “current” could have just as easily have been left out as it appears the controversy in economics is ever ongoing.

  2. “Intertemporal optimization” is, itself, a problematic concept. Even before we try to imagine a crowd doing it together, don’t we have to be able to imagine an individual practicing such a regime? Could she? What would that look like through life? And, by what means would it be implemented? How does optimizing behavior handle sunk-cost investments in consumer durables and capital, alongside monetary savings and financial contracts?
    In the explanation of business cycles, do we even need heroic behavioral assumptions at base? The simple facts of sunk-costs in automobiles and houses and factories (never mind technology shocks, whatever they might be or population for that matter) dictate that rates of production and consumption must vary from steady vector rates of growth.

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