Real Business Cycle Theory

Few aspects of economics are as interesting to the public as the frequent fluctuations of the economy, especially recessions, panics, and depressions. Unfortunately, then, we find that economists are utterly divided as to the causes of such cycles and as to what, if anything, can or should be done about them. A theory popular with those of the freshwater persuasion is the so-called Real Business Cycle theory, or RBC.

One basic aspect of RBC is that it seeks explanation of the business cycle in so-called exogenous factors, sometimes called technology shocks: bad weather, new inventions, environmental regulations. In particular it rejects the so-called endogenous causes postulated by Keynesian and monetarist economists. Most fundamental, though, is the idea that the markets response to the exogenous factors is optimal in that it maximizes utility. Keynesians and monetarists, by contrast, see recession and depressions as market failures. Consequently, any interventions, either monetary or fiscal, are likely to be at best useless and at worst harmful.

There is, I suppose, a certain attractiveness to a theory seeks explanation in relatively concrete facts like weather and technological progress rather that in an abstraction like money, which is only a symbolic representation of that production.

To me, of course, that's extremely silly. If there is anything physics has taught us about complex systems, it's that complexity gives rise to emergent behaviors. Dynamical systems theory has also taught us that it probably doesn't matter, in many cases, if this or that initial condition or perturbation gives to some evolution or other. Sensitive dependence on initial conditions means that it doesn't really matter if the precipitating shock is exogenous - the interesting dynamics are still endogenous.

Of course there are real exogenous shocks, and some of them have dramatic effects on the economy. The nonsense is concentrated in the notion that the market is optimal. This notion is predicated on some manifestly false assumptions, and has more to do with wishful thinking than science. The falsity of the assumption, by the way, is quite independent of the question of whether any agent could do a better job of pricing assets than the market. I would love to debate that point with any RBCer who would dare.

Mostly, though, RBC is a religious-ideological notion. It is built to be impervious to facts. The economy is a black box controlled from the outside and it's optimal by fiat.