Is the technology-driven real business cycle hypothesis dead? Shocks and aggregate fluctuations revisited

This 2005 Journal of Monetary Economics paper (circulated as NBER Working Paper 8726, January 2002) subjects a startling empirical result – that identified “technology shocks” appear to reduce labor input, the opposite of what standard real-business-cycle (RBC) theory predicts – to a battery of plausibility checks, and then asks whether standard dynamic general-equilibrium (DGE) models can be modified, without invoking sticky prices, to match it. The authors begin skeptical of Galí’s (1999) long-run-restriction identification of technology shocks, but after deriving additional over-identifying restrictions from a standard growth model, comparing the shock’s effects on wages and consumption against the model’s qualitative predictions, and testing whether oil shocks, Romer-dated monetary policy changes, or military buildups can explain the identified shock (they cannot, with the lowest p-value only 0.12), the paper concludes the identified disturbance really does look like a technology shock – “a better candidate than the Solow residual for a true technology shock.” Facing this result, the authors then show that two flexible-price modifications to a standard DGE model – one combining habit formation in consumption with investment adjustment costs, the other replacing the production function with a short-run Leontief (fixed-proportions) technology – can each reproduce a temporary decline in hours worked after a positive technology shock, through different internal mechanisms than Galí’s preferred sticky-price explanation. Despite this success, the authors are explicit that neither modification revives technology shocks as a plausible primary driver of business cycles: in their words, “the original technology-driven real business cycle hypothesis does appear to be dead,” since the data instead point to a separate, non-technology (“demand”) shock as the source of the standard positive comovement among output, hours, consumption, and investment that constitutes a textbook business cycle.

Neville Francis | Macro Paper Warehouse

Is the technology-driven real business cycle hypothesis dead? Shocks and aggregate fluctuations revisited