Real business cycle theory

"Real business cycle theory never got close to the world of policy—not even the most extreme conservative politicians were prepared to tell the American people to welcome recessions as part of the natural and optimal course of events. And instead of spreading its intellectual range, the movement became increasingly ingrown over time. Indeed, one observer described it as becoming like a fringe political movement that successively purges itself of the ideologically impure until only a handful of members are left."

"Iowa had a Depression too but I dont know if the money supply in Iowa fell during that period. But I guess Id have to have better reasons man that for giving up on the monetary explanation. The timing and the magnitudes are just right, totally convincing, if you go back and read the Friedman and Schwartz chapter on the Great Depression. But how did it work? We should be able to write down an economic model that kind of explains the workings. How did it happen that bank failures and monetary declines translated into huge movements in employment and production? We just dont have a decent theoretical model. Maybe Rapping and I thought we had, but I dont think we did and I dont think anyone else does now either. I think that has been the problem right along. Is there some other explanation for the 1930s? I dont know. I told Prescott I’d hate to have to rewrite the Friedman and Schwartz book where the role Friedman and Schwartz assigned to monetary collapses is assigned instead to productivity shocks. Where is the productivity shock that cuts output in half in that period? Is it a flood or a hurricane? If it really happened, shouldn’t we be able to see it in the data?"

"The other response [to the failure of the Lucas project], by those who had already invested vast effort and their careers in the Lucas project, was to drop the whole original purpose of the project, which was to explain why demand shocks matter. They turned instead to real business cycle models, which asserted that the ups and downs of the economy are caused by technological shocks magnified by rational labor supply responses. Full disclosure: this has always seemed absurd to me; as many have pointed out, the idea that the unemployed during a recession are voluntarily choosing to take time off is something only a professor could believe. But the math was impressive, and RBC became a self-contained, self-replicating intellectual world. [...] The Lesser Depression arrives. It’s clearly not a technological shock; clearly, also, nobody is confused about whether we’re in a slump, as the old Lucas model required."