Critisisms of the RBC model Summers

RBC denies Basic Propositions of mainstream economics. Assuming

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Monetary policy has no effect on economic output

Fiscal policy only effects the economy through incentives
Demand shocks do not exist

RBC theory proposes a model economy which is good at representing

some economic situations and as such can make some useful predictions,
but this artificial and simplified model makes it ineffective in 4 ways.

Incorrect Parameters: The model functions on assumptions which are not true
in the real economy.
-

Assumes elasticity of labour supply (because consumption is seen as

elastic) In reality labour is sticky, people dont change their work routines
with small changes in their wages
Assumes an interest rate of 4% when the reality is closer to 1%
Assumes around 1/3 of the populations hours are spent in the workforce
when it is really closer to 1/6

Incorrect Shocks
-

Little evidence for the so called technology shocks

o Even oil shocks, the most prominent technological shock appeared
not to slow the American economy in the 70s
o These shocks could be easily be explained by already understood
macro-principles which arent included in the model. (changes from
underemployment to full employment for example.)
Equally, there is strong evidence for firms changing their productivity in
relation to falls in demand (demand shocks). Demand shocks are rejected
by the model, despite better explaining the cyclical nature of the business
cycle rather than repeated positive and negative tech shocks.

Lack of Price Data

-

RBC theory is a price-free analysis because of this it is difficult to model

the changes in demand to changing prices; making demand shocks look
like supply side issues.

Failures to Exchange.
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In cases of extreme economic downturn, such as the great depression,

there is an issue of failures to exchange caused by sticky wages and
prices. Businesses had goods they wanted to sell and people wanted to

work but prices and wages didnt fall. The RBC model doesnt take into
account this failure of firms to exchange, assuming the market is perfectly
efficient.

Responses to the Critique Prescott

-

Model uses competitive equilibrium which assumes relative prices

Technology shocks are misrepresented by summers, they are not
large singular events, but micro-changes in the productivity of
workers
The model does not claim tech shocks explain every change in the
economy, just the vast majority, random extreme events such as
the breakdown of the finance system in the 1930s are still respected
in the model
Paramaters acceptable depending on data used (simplification, in
the paper he gives examples of alternative data and models but the
general argument is the parameters are acceptable.)
Technology shocks are caused by variations in the capital use rate
(as unemployment lowers there is a greater drive to increase
productivity through tech.)
Under-employment is not cyclical so does not offer us an
explanation to cyclical business cycles.
RBC is built upon a foundation used in neo-classical economics to
predict growth which gives it additional strength. Summers uses this
model himself.