Staff Report 494

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A Reassessment of Real Business Cycle Theory

Ellen R. McGrattan - Consultant
Edward C. Prescott - Senior Monetary Advisor

Revised March 14, 2014

Abstract
During the downturn of 2008–2009, output and hours fell significantly while labor productivity rose. These facts have led many to conclude that there is a significant deviation between observations and current macrotheories that assume business cycles are driven, at least in part, by fluctuations in total factor productivities of firms. We show that once investment in intangible capital is included in the analysis, there is no inconsistency. Measured labor productivity rises if the fall in output is underestimated; this occurs when there are large unmeasured intangible investments. Microevidence suggests that these investments are large and cyclically important.


Forthcoming In: American Economic Review Papers and Proceedings

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