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Business Cycle Accounting

Staff Report 328 | Published December 1, 2006

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Patrick J. Kehoe Monetary Advisor
V. V. Chari Consultant
Business Cycle Accounting


We propose a simple method to help researchers develop quantitative models of economic fluctuations. The method rests on the insight that many models are equivalent to a prototype growth model with time-varying wedges which resemble productivity, labor and investment taxes, and government consumption. Wedges corresponding to these variables—efficiency, labor, investment, and government consumption wedges—are measured and then fed back into the model in order to assess the fraction of various fluctuations they account for. Applying this method to U.S. data for the Great Depression and the 1982 recession reveals that the efficiency and labor wedges together account for essentially all of the fluctuations; the investment wedge plays a decidedly tertiary role, and the government consumption wedge, none. Analyses of the entire postwar period and alternative model specifications support these results. Models with frictions manifested primarily as investment wedges are thus not promising for the study of business cycles. (See Additional Material for a response to Christiano and Davis (2006).)

Published in: _Econometrica_ (Vol. 75, No. 3, May 2007, pp. 781-836) See related papers: [Staff Report 362: _Appendices: Business Cycle Accounting_]( Quarterly Review article (Vol. 27, No. 2, Spring 2003) [_Accounting for the Great Depression_]( [Additional Materials]( [M-files and Ftools](