Why Real Business Cycle models can’t be taken seriously
from Lars Syll
They 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.
Real Business Cycle theory 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 Keynes had it — It is better to be vaguely right than precisely wrong …
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Real-World Economics Review Blog 
Inter-temporal transfers don’t work, as a rule. They work for individuals in the short term, like I may choose to work harder than usual for a few months, maybe a few years if I’m young, to achieve better income later. Or if a company spends retained profits to build a factory or a technology that’s a physical transfer to the future.
But these are the exceptions. Mostly, inter-temporal transfers are a fiction. Pensions are not inter-temporal transfers, they’re present transfers from net producers (working people) to net consumers (pensioners). Sovereign debt isn’t an inter-temporal transfer. It’s an exchange of more liquid more inflationary money stock (money) for less liquid less inflationary money stock (bonds).
An interesting result if you look at business cycles without the inter-temporal transfer myths is that bubbles are good! During the expansionary phase of a bubble the economy is booming and everyone seems happy: Producers are producing, consumers are consuming, employees are employed, and spirits are high. In particular *nobody seems to be sacrificing present welfare for inter-temporal benefit*. Those German auto workers making free cars for the Greeks and Spaniards before 2007, they enjoyed being employed making them.
This points to the bubble as an indication for what the steady-state economy would look like if surplus recycling mechanisms were working optimally. No working person is unhappy during a bubble. A bubble presents illusory inter-temporal returns to capital owners, inducing them to spend their surplus back into the economy, restoring value flows and boosting general welfare. We call a bubble unsustainable, but it’s only unsustainable if we internalise profit accumulation as the norm.
Bubbles are a very cyclic substitute for the steady-state surplus recycling that our economies lack. Embrace them! Study the value flows that obtain during a bubble’s expansionary phase and make them the norm, by substituting steady surplus recycling for illusory gain and bust.
July 28, 2013
Once again Lars Syll has hammered another nail into the thick skull of neoclassical
[general} equilibrium models: especially their shot-gun marriage with the cult of shocks: Is there any aspect of reality in the universe of economic events that THEY can’t relegate to a “shock”; or ‘residual operator’ that can be “renormalized” into an equilibrium model ?
The greatest victim of this kind of desperately tautological thinking has been the role of “technos”, the Promethean Imperative, in the evolution of economic history. Technological evolution cannot be squeezed into the role of vaguely defined “technology-induced changes in productivity” ???: Or a residual operator a la Robert Solow. It’s a process, a complex interactive one. Because Business Cycles are real events in Technological Time, with other causes impacting on them locally .
To-day’s article by M. Syll is a revisit to his equally revealing one of August 10, 2013;
REAL BUSINESS CYCLES–TRANSMOGRIFYING OBFUSCATION. Please scroll down on that one to August 11, 2013, by Norman L. Roth.
Please GOOGLE:
[1] Norman L. Roth
[2] Norman L. Roth, Technological Time
{3}Norman L. Roth, Current Conception of the Standard of Life
{4} Norman L. Roth, Origins of Markets
What comes after debunking?
Comment on ‘Why Real Business Cycle models can’t be taken seriously’
Orthodoxy is a failure and even laypersons understand intuitively that the behavior of the economy as a whole cannot be explained by the behavioral assumption of constrained optimization of individual agents. This has been a non-starter since Jevons-Walras-Menger and Heterodoxy has always said so. Yet, the question is not how this ‘pure nonsense’ ‘could be awarded The Sveriges Riksbank Prize in Economic Sciences’ but why traditional Heterodoxy could not produce something better than this ridiculous specimen of proto-science?
Orthodoxy is long dead but it has not been buried. Why is this scientific zombie (Quiggin, 2010) still around?
“The main reason for the considerable acceptance of the approach is that fundamental rule of scientific combat: it takes a theory to beat a theory. No amount of skepticism about the fertility of a theory can deter its use unless the skeptic can point to another route by which the scientific problem of regulation can be studied successfully.” (Stigler, 1983, p. 541)
So, this is the pork-barrel deal: Orthodoxy does not vanish because of proven scientific incompetence but only if Heterodoxy presents something better.
To do them the favor is the pleasant duty of Constructive Heterodoxy. Let us throw out the ‘real’ business cycle by advancing to the interaction of nominal and real variables which constitutes the business cycle of the economy we happen to live in (2012).
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2012). Intertwined Real and Monetary Stochastic Business Cycles. SSRN Working Paper Series, 2173528: 1–27. URL
http://ssrn.com/abstract=2173528.
Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us. Princeton, NJ, Oxford: Princeton University Press.
Stigler, G. J. (1983). Nobel Lecture: The Process and Progress of Economics. Journal of Political Economy, 91(4): 529–545. URL
http://www.jstor.org/stable/1831067.