The New Classical Revolution: Business Cycles

The New Classical revolution  in macroeconomics finds important places in both the study of business cycles and in monetary policy. The two applications are closely related of course, but can nonetheless be studied separately. This section concentrates on the literature related specifically to business cycles. The New Classical paradigm, in this setting involves the study of business cycles in the setting of market-clearing, competitive equilibia. Students have already had a lot of exposure to competitive equilibrium business cycle models, at least the real ones (as opposed to monetary ones). The readings here are therefore highly selective in a way that fits with the aims of this course. The literature can be divided into two groups: models in which money is important, and models in which it is absent. The seminal monetary model is (again) Lucas 1973. This is hard going and it has been put into the supplementary reading list. The paper is accompanied by more accessible studies (in rather different settings) by Lucas (1975) and by Lucas and Stokey (1983).The most famous real business cycle (RBC) model is Kydland and Prescott (1982). Again, this has been put in the supplementary list, although it is an accessible piece.   

My recommended text for the main reading is Lucas' Yrjo Jahnsson lectures, given in Helsinki in 1985 and published in 1987. It is still a great read. Its combines a review of models (real and monetary) to 1985, an evaluation of the evidence, and an insight into the mindset of new classical economists, all packaged in Lucas' wonderful writing style.

In the supplementary readings, the papers by Plosser and Prescott are relatively standard RBC models. Hansen and Wright (1992) describe some more recent modifications to the basic model and evaluate their performance.The Hansen and Prescott paper is short and readable, and is a good example of what people do with RBC models when they are not in a mood to debate whether they are any good at all.

Finally, Summers (1986) and Prescott (1986) offer evaluations from two sides of the field; they do a pretty good job of showing how mean the debate on RBC theory can get.

  
Required Reading
Lucas, Robert E. (1987): Models of Business Cycles. London: Blackwell.
  
Supplementary Readings

A. Monetary Business Cycles
Lucas, Robert E. (1973): "Expectations and the Neutrality of Money." Journal of Economic Theory, 4:103-124.
Lucas, Robert E. (1975): "An Equilibrium Model of the Business Cycle."Journal of Political Economy, 83(6):1113-1144.
Lucas, Robert E., and Nancy L. Stokey (1983): "Optimal Fiscal and Monetary Policy in an Economy Without Capital." Journal of Monetary Economics, 12:55-93.

B. Real Business Cycles
Kydland, Finn E., and Edward C. Prescott (1982): "Time to Build and Aggregate Fluctuations." Econometrica, 50:1345-1370.
Plosser, Charles (1989): "Understanding Real Business Cycles." Journal of Economic Perspectives, 3:51-78.
Prescott, Edward C.  (1986): "Theory Ahead of Business Cycle Measurement." Federal Reserve Bank of Minneapolis Quarterly Review, 10:23-27 (Fall). Reprinted in Preston J. Miller, ed., The Rational Expectations Revolution. Readings from the Front Line. Cambridge, MA: MIT Press (1994).
Hansen, Gary D. and Edward C. Prescott (1993): "Did Technology Shocks Cause the 1990-91 Recession?" American Economic Review Papers and Proceedings, 83(2):280-86.
Hansen, Gary D. and Randall Wright (1992): "The Labor Market in Real Business Cycle Theory." Federal Reserve Bank of Minneapolis Quarterly Review, 10: (Fall). Reprinted in Preston J. Miller, ed., The Rational Expectations Revolution. Readings from the Front Line. Cambridge, MA: MIT Press (1994).
Summers, Lawrence H. (1986): "Some Skeptical Observations on Real Business Cycle Theory." Federal Reserve Bank of Minneapolis Quarterly Review, 10: (Fall). Reprinted in Preston J. Miller, ed., The Rational Expectations Revolution. Readings from the Front Line. Cambridge, MA: MIT Press (1994).
Prescott, Edward C.  (1986): "Response to a Skeptic." Federal Reserve Bank of Minneapolis Quarterly Review,10: (Fall). Reprinted in Preston J. Miller, ed., The Rational Expectations Revolution. Readings from the Front Line. Cambridge, MA: MIT Press (1994).
Mankiw, N. Gregory (1989): "Real Business Cycles: A New Keynesian Perspective." Journal of Economic Perspectives, 3:79-90.