Introduction
The Real Business Cycle theory was first initiated by Kydland and Prescott in 1982, which concentrate on explaining the economic fluctuations driven by the “real” exogenous technology shocks. It described the general philosophy of any New Classical approach to business cycle analysis. This essay is going to explore their main successes and drawbacks by firstly providing an overview of the historical background of the model. Then it will discuss some general achievements, extensions to, and criticisms before concluding.
The Historical Background
The dominating Keynesian paradigm seemed particularly successful in explaining the macroeconomic fluctuations before the mid-1970s while it became more apparent that later development in the real world revealed serious shortcomings of the earlier analysis which could not be seen as a proper interpretation for understanding the business cycles. According to Plosser (1989), the view that Keynesian economics was an empirical success even if it lacked sound theoretical foundations could no longer be taken seriously. The essential flaw in the Keynesian interpretation of macroeconomic phenomenon was the absence of a consistent foundation based on the choice-theoretic framework of microeconomics. With this emerging stagflation phenomenon in mind, the quiet different approaches to the explanation of business cycles fluctuations have been pursued. And the revival of business cycle theory is brought by the development of New Classical macroeconomics. Friedman (1968) and Lucas (1976) critically posed a challenge to the Keynesian model. Friedman argued that the long-run Phillips Curve should be vertical and the sustained inflation is compatible with any level of real demand of goods. Lucas...
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...planation of the monetary transmission mechanism.”
Conclusion:
All in all, the Real Business Cycle theory has been very controversial and there are many devastating criticisms toward its advocates, as there exist many unresolved problems. However, even if the final consensus is that RBC theory has many imperfections, it indeed changes the way macroeconomics modelled. As what Stadler(1994) praises, “ It has introduced into macroeconomics computable general equilibrium models that can replicate certain characteristics of real data sets.” The incorporation of more features of reality into these models can be achieved when the technical frontier moves outwards. Thus, the contributions of RBC theory not only altered our conventional views of business cycles significantly but also brought in creative methods for macroeconomic research and revolutionary policy appraisal.
The Poole Model is a macroeconomic model where its main objective is to answer the discussion on whether monetary policy should be conducted using a money-supply rule or an interest-rate rule when managing the economy. In the Poole Model, the Central Bank’s objective is to minimize the loss function:
In conclusion, regardless of Macropoland’s current economic condition, it is fair to say that it is all part of the business cycle. The business cycle has three parts: peak, trough, and peak. The peak is the date that the recession starts. In Macropoland’s case, the peak would be at the beginning of 1973, its trough somewhere between 1973 and 1974, and then its peak again at 1974. In the second scenario, Macropoland is either at its trough, where it is about to head up again because of its low inflation rate, or it is at its expansion, on its way to heading to its next peak.
Classical economists believe that these are “temporary” changes that will correct themselves in the long run. They feel that an economy will always tend towards operating at its potential output as given by the long-run aggregate supply curve. Nothing needs to be done by the government because normal market forces will serve to self-correct these issues. On the other hand, Keynesian economics argue that the gap between the lower and the potential levels of output is due to a change in aggregate demand. They argue that this gap can exist for a long time and that the gap can be pushed to close faster if the government enacts fiscal and monetary policies.
In The Return of Depression Economics and the Crisis of 2008, Paul Krugman warns us that America’s gloomy future might parallel those of other countries. Like diseases that are making a stronger, more resistant comeback, the causes of the Great Depression are looming ahead and much more probable now after the great housing bubble in 2002. In his new and revised book, he emphasizes even more on the busts of Japan and the crises in Latin America (i.e: Argentina), and explains how and why several specific events--recessions, inflationary spiraling, currency devaluations--happened in many countries. Although he still does not give us any solid options or specific steps to take to save America other than those proposed by other economists, he thoroughly examines international policies and coherently explains to us average citizens how the world is globalizing--that the world is becoming flatter and countries are now even more dependent on each other.
Keynes and Hayek represent different options. Should we steer markets or set them free? “Which way should we choose, More bottom up or more top down?” (Fight of the Century). These questions reflect the opposite ways Keynes and Hayek address the economy. Keynes wants to “steer” the economy from the “top down.” From his understanding of the economy, Keynes theorizes that the market can be directed by those with the power to do so to accomplish goals leading to a prosperous economy. This is the basis in his approach to dealing with recessions where the government or central bank manipulates the economy. The other side is a free market from the “bottom up” on which Hayek stakes his claim. Instead of steering the economy, Hayek proposes to leave it alone. Do not try to control it, but let the market determine the interest rate and price level, as it eventually will, through supply and demand. In this way, control is not exerted downward, but reality is expressed from basic economic forces. Fundamentally, Keynes’s model focuses more on the spending and consumption aspects of GDP, and Hayek’s approach focuses more on the investing aspect which flows from saving. These are the options from which to choose. Keynes vs. Hayek, Short run vs. long run, controlled vs. free, top down vs. bottom up, each possibility has its negatives and positives. This debate is not wrapped up
middle of paper ... ... 06 Nov.2011 Cochran, J. P., and F. R. Glahe. “The Keynes-Hayek Debate: Lessons for Contemporary Business Cycle Theorists.” History of Political Economy 26.1. (1994): 69-94.
Over the past five years the Australian economy has gone through many changes experiencing both the peaks and troughs associated with business cycle.
ROBINSON, Joan (1965b). “The General Theory after Twenty-Five Years”. Collected Economic Papers, vol. III, pp. 100-2.
“Microeconomics and macroeconomics can be described in terms of small-scale vs. large-scale or in terms of partial vs. general equilibrium. Perhaps the most important distinction, however, is in terms of the role of equilibrium. While issues in microeconomics seldom challenge the notion of a naturally occurring equilibrium, the existence of business cycles and, especially, unemployment suggests too many observers that macroeconomics raises issues of a different character.” (McConnell & Brue, 2004).
My research of Classical Economics and Keynesian Economics has given me the opportunity to form an opinion on this greatly debated topic in economics. After researching this topic in great lengths, I have determined the Keynesian Economics far exceeds greatness for America compared to that of Classical Economics. I will begin my paper by first addressing my understanding of both economic theories, I will then compare and contrast both theories, and end my paper with my opinions on why I believe Keynesian Economics is what is best for America.
Keynesian method and world-systems theory deserve special attention. It is Keynesianism that makes possible for the radical political economists to apply the bipolar model, centered on
Difficulties in Formulating Macroeconomic Policy Policy makers try to influence the behaviour of broad economic aggregates in order to improve the performance of the economy. The main macroeconomic objectives of policy are: a high and relatively stable level of employment; a stable general price level; a growing level of real income (economic growth); balance of payments equilibrium, and certain distributional aims. This essay will go through what these difficulties are and examine how these difficulties affect the policy maker when they attempt to formulate macroeconomic policy. It is difficult to provide a single decisive factor for policy evaluation as a change in political and/or economic circumstances may result in declared objectives being changed or reversed. Economists can give advice on the feasibility and desirability of policies designed to attain the ultimate targets, however, the ultimate responsibility lies with the policy maker.
Ferguson, S (1999) Keynesian Theory and its implication, College of Management and Economics, Canada University, 298-312
Rittenberg, L. and Tregarthen, T. (2012). Macroeconomics Principles V. 2.0. Licensed under Creative Commons by-nc-sa 3.0 (https://creativecommons.org/licenses/by-nc-sa/3.0/)
The macroeconomic environment is a dynamic environment, which could not remain unchanged (Gajewsky 2015). There are many factors influence the global macroeconomic environment, such as interest rate, exchange rate, GDP，aggregate demand, monetary policy and other macroeconomic variable (Oxelheim and Wihlborg 2008). These factors are closely associated with commodity price.