The Real Business Cycles Approach

Until now, we have explored how New Classical (hereafter, NC) economics has reinstated and emphasized the concept of cyclical fluctuations, grounded in the assumption of continuous market clearing across all markets and the rational expectation hypothesis characterizing the behavior of economic agents. According to NC economists, the primary causes of fluctuations in real GDP are attributed to insufficient information regarding the distinction between relative prices and the general price level, along with monetary shocks. This explanation for the origin of business fluctuations not only challenged Keynesian orthodoxy but also laid the groundwork for the emergence of Real Business Cycles (RBC) and New Keynesian economics. This chapter commences with a historical overview of the discourse on business cycles and subsequently delves into the key characteristics of the RBC approach. The discussion then turns to the exploration of the causes of business cycles, differentiating between real and monetary factors, and the separation of cycles from growth (trend). A brief overview of RBC simulation models is presented, followed by an examination of the policy implications associated with RBC. The chapter concludes with a summary and critical reflections on this approach that garnered significant attention, at least until the onset of the post-2007 crisis.