Modern Macroeconomics.pdf

The real business cycle school 299driven by real aggregate demand, mainly unstable investment expenditures,with monetary factors downgraded and supply-side phenomena providing theconstraints which give rise to business cycle turning points (see Laidler,1992a). Whatever their merits, multiplier–accelerator models ceased to be afocus of active research by the early 1960s. To a large extent this reflected theimpact of the Keynesian revolution, which shifted the focus of macroeconomicanalysis away from business cycle phenomena to the development ofmethods and policies which could improve macroeconomic performance.Such was the confidence of some economists that the business cycle was nolonger a major problem that by 1969 some were even considering the question:‘Is the Business Cycle Obsolete?’ (Bronfenbrenner, 1969). Similarconjectures about ‘The End of the Business Cycle’ appeared during the late1990s, often framed in terms of discussions of the ‘new economy’; see, forexample, Weber (1997). We have already seen that during the 1970s and1980s the business cycle returned with a vengeance (relative to the norm forinstability post 1945) and how dissatisfaction with Keynesian models led tomonetarist and new classical counter-revolutions.The most recent developments in business cycle research inspired by equilibriumtheorists during the 1980s have proved to be a challenge to all theearlier models relying on aggregate demand fluctuations as the main sourceof instability. Hence real business cycle theory is not only a competitor to the‘old’ Keynesian macroeconomics of the neoclassical synthesis period but alsorepresents a serious challenge to all monetarist and early MEBCT new classicalmodels.In addition to the above influences, the transition from monetary to realtheories of the business cycle was further stimulated by two other importantdevelopments. First, the supply shocks associated with the two OPEC oil priceincreases during the 1970s made macroeconomists more aware of the importanceof supply-side factors in explaining macroeconomic instability (Blinder,1979). These events, together with the apparent failure of the demand-orientedKeynesian model to account adequately for rising unemployment accompaniedby accelerating inflation, forced all macroeconomists to devote increasing researcheffort to the construction of macroeconomic theories where the supplyside has coherent microfoundations (see Chapter 7). Second, the seminal workof Nelson and Plosser (1982) suggested that real shocks may be far moreimportant than monetary shocks in explaining the path of aggregate output overtime. Nelson and Plosser argue that the evidence is consistent with the propositionthat output follows a path, which could best be described as a ‘randomwalk’.Before examining the contribution of Nelson and Plosser in more detail itis important to note that the desire of both Keynesian and new classicaleconomists to build better microfoundations for the supply side of their