Real Business Cycles

Abstract

In this paper we demonstrate how certain very ordinary economic principles lead maximizing individuals to choose consumption-production plans that display many of the characteristics commonly associated with business cycles. Our explanation is entirely consistent with (i) rational expectations, (ii) complete current information, (iii) stable preferences, (iv) no technological change, (v) no long-lived commodities, (vi) no frictions or adjustment costs, (vii) no government, (viii) no money, and (ix) no serial dependence in the stochastic elements of the environment. We also provide a completely worked out example of the type of artificial economy we have in mind. The time-series properties of the example exhibit some major features of observed business cycles. Although this type of model may not be capable of explaining all of the regularities in actual business cycles, we believe that it provides a useful, well-defined benchmark for assessing the relative importance of factors (e.g., monetary disturbances) that we have deliberately ignored.