by RBC methodology — three decades of intellectual regress Neoclassical economics is known for its illicit use of garbled language which hides and convolutes instead of explains … An interesting example is the chapter by Edward Prescott, titled ‘RBC Methodology and the Development of Aggregate Economic Theory’ (ungated version). Let’s first give the floor to him (emphasis added), mind that ‘leisure’ means ‘measured unemployment’.: “What turned out to be the big breakthrough was the use of growth theory to study business cycle fluctuations … based on micro theory reasoning, dynamic economic theory was viewed as being useless in understanding business cycle fluctuations. This view arose because, cyclically, leisure and consumption moved in opposite
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RBC methodology — three decades of intellectual regress
Neoclassical economics is known for its illicit use of garbled language which hides and convolutes instead of explains … An interesting example is the chapter by Edward Prescott, titled ‘RBC Methodology and the Development of Aggregate Economic Theory’ (ungated version). Let’s first give the floor to him (emphasis added), mind that ‘leisure’ means ‘measured unemployment’.:
“What turned out to be the big breakthrough was the use of growth theory to study business cycle fluctuations … based on micro theory reasoning, dynamic economic theory was viewed as being useless in understanding business cycle fluctuations. This view arose because, cyclically, leisure and consumption moved in opposite directions. Being that these goods are both normal goods and there is little cyclical movement in their relative price, micro reasoning leads to the conclusion that leisure should move procyclically when in fact it moves strongly countercyclically. Another fact is that labor productivity is a procyclical variable; this runs counter to the prediction of micro theory that it should be countercyclical, given the aggregate labor input to production. Micro reasoning leads to the incorrect conclusion that these aggregate observations violated the law of diminishing returns. In order to use growth theory to study business cycle fluctuations, the investment-consumption decision and the labor-leisure decision must be endogenized. Kydland and Prescott (1982) introduced an aggregate household to accomplish this. We restricted attention to the household utility function for which the model economies had a balanced growth path, and this balanced growth path displayed the growth facts. With this extension, growth theory and business cycle theory were integrated. It turned out that the predictions of dynamic aggregate theory were consistent with the business cycle facts that ran counter to the conclusion of those using microeconomic reasoning”
Translation: “Depressions are caused because people want to work less. Yes, we measure unemployment and it goes up when spending declines. But by assuming a ‘balanced growth path’ we define this away: the growth path is by assumption balanced so no unemployment exists and what we measure is leisure, not unemployment. People (sorry, ‘the representative consumer’) sometimes suddenly want to work a lot less, hence 25% unemployment (sorry, leisure) in countries like Greece and Spain and during the Great Depression in the USA. Hey, problem solved (and f*** the statistics)!”