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\title{\vspace{1.6cm} \\
	{\LARGE Lecture 6}\\[1ex]
{\LARGE Business Cycle Macro and Lucas Critique}\\
	\noindent \hspace{-0.3cm} \rule{12.8cm}{0.6pt} \vspace{-0.7cm}}
\author{Macroeconomics EC2B1\\[3ex]  Benjamin Moll \\\vspace{0.5cm}}
\institute{London School of Economics, Winter 2024}





\begin{document}

%%%%%%%%%%%%%%%%%%

{
\setbeamertemplate{footline}{}
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\titlepage
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\begin{frame}{Reminder: business cycles (from EC1B1 notes)}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=\textwidth]{figures/EC1B1_business_cycles1} 
\end{figure}
\end{frame}



\begin{frame}{Reminder: business cycles (from EC1B1 notes)}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=\textwidth]{figures/EC1B1_business_cycles2} 
\end{figure}
\end{frame}


\begin{frame}{Reminder: business cycles (from EC1B1 notes)}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=\textwidth]{figures/EC1B1_business_cycles3} 
\end{figure}
\end{frame}




\begin{frame}{Plan}
\be
\bigskip
\item Brief history of business cycle macro until the 1980s
\bi
\medskip
\item key idea: Lucas critique
\ei
\bigskip
\item A two-period Real Business Cycle model = the model from lecture 5
\bigskip
\item The fully-fledged Real Business Cycle model
\bigskip
\item Criticisms of the RBC model
\ee
\end{frame}


\begin{frame}{Readings}
\be
\bigskip
\item EC1B1 lecture notes, in particular lecture 6
\bigskip
\item Kurlat, chapters 12 and 13
\bigskip
\item Jones, chapter 15 ``DSGE Models: the Frontier of Business Cycle Research"
\bigskip
\item NPR Planet Money episode on Bob Lucas and Lucas critique\\[-0.5ex] {\notsotiny \url{https://www.npr.org/2023/05/17/1176781995/the-man-who-busted-the-inflation-employment-myth}}
\bigskip
\item Ivan Werning (2023) ``Lucas Miracles" {\notsotiny \url{https://economics.mit.edu/sites/default/files/inline-files/Translated\%20Lucas\%20Miracles\%20by\%20Ivan\%20Werning.pdf}}
\ee
\end{frame}





\begin{frame}
\renewcommand{\baselinestretch}{1}
\vspace{3.2cm}
\begin{center}
{\huge A brief history of business cycle macro}
\end{center}
\end{frame}


\begin{frame}{A brief history of business cycle macro until the 1980s}
As with all attempts to fit complex history into simple narrative, won't do justice \\
\bigskip
Some key models and ideas you should know:
\bi
\bigskip
\item 1930s: Keynesian model (Keynesian cross, IS-LM or IS-MP-PC)
\bigskip
\item 1970s
\bi
\medskip
\item Lucas critique and importance of microfoundations
\medskip
\item rational expectations
\ei
\bigskip
\item 1980s: real business cycle (RBC) model
\bigskip
\item (to be continued in later lectures)
\ei
\end{frame}


\begin{frame}{1930s: Keynesian model}
\bi
\item Macroeconomics becomes separate field in 1930s, starting with Keynes
\bigskip
\item Keynes (1936) ``The General Theory of Employment, Interest and Money"
\bigskip
\item Keynesian cross and IS-LM model (or its modern incarnation = IS-MP-PC)
\bigskip
\item One key policy prescription: countercyclical fiscal policy, i.e. provide fiscal stimulus in recessions
\bigskip
\item Most common methodology until 1970s: large-scale macroeconometric models without microfoundations (i.e. no utility or profit maximization)
\bi
\medskip
\item write down big models with many equations like Keynesian consumption function $C = \alpha + \gamma(Y-T)$, Phillips curve, etc
\medskip
\item estimate these equations using time-series data
\medskip
\item  conduct policy counterfactuals, e.g. monetary \& fiscal policy
\ei
\ei
\end{frame}

\begin{frame}{Aside: Keynesian IS-LM is actually due to Hicks (1937)}
\bigskip
\begin{figure}[tph]
	\centering
\includegraphics[width=.49\textwidth]{figures/hicks1} 
\includegraphics[width=.49\textwidth]{figures/hicks2} 
\end{figure}
\end{frame}



\begin{frame}{1970s: Lucas critique and importance of microfoundations}
\vspace{-3mm}
\bi
\item Critique of 1970s-style macroecometric models without microfoundations
\medskip
\item Lucas (1976) ``Econometric Policy Evaluation: A Critique". Idea:
\bi
\smallskip
\item you cannot use these macroeconometric models for policy evaluation because the parameters are \tr{not policy-invariant}
\smallskip
\item i.e. you'd expect these parameters to change when policy changes
\smallskip
\item in a nutshell: \tr{behavior changes with the rules of the game}. Models must allow for this.
\ei
\bigskip
\item Lucas aims critique at Phillips curve estimated with historical data \& ``the inference that permanent inflation will induce a permanent economic high"
\bigskip
\item ... but the point is \tr{much more general}
\bi
\medskip
\item coffee-drinking example in NPR podcast
\medskip
\item Tom Sargent's (1980) American football example \\[-0.7ex] {\scriptsize \url{https://researchdatabase.minneapolisfed.org/downloads/kh04dp86z}}
\ei
\ei
\end{frame}



\begin{frame}{Lucas (1976) lays it out nicely}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=.85\textwidth]{figures/lucas-critique} 
\end{figure}
\end{frame}



\begin{frame}{Example: our models predict that MPCs not policy-invariant}
\vspace{-3mm}
\bi
\item Recall microfounded consumption model from Lecture 4
\medskip
\item MPC out of transitory income shock
$$\frac{\partial c_1}{\partial y_1} = \frac{\left(\frac{1}{\beta (1+r)} \right)^\sigma (1+r)}{1+\left(\frac{1}{\beta (1+r)} \right)^\sigma (1+r)} $$
where $r$ = interest rate, $\beta$ = discount factor, $\sigma$ = IES
\medskip
\item So can write a consumption function
$$c_1 = \gamma y_1 + ... , \quad \mbox{with} \quad \gamma = \frac{\left(\frac{1}{\beta (1+r)} \right)^\sigma (1+r)}{1+\left(\frac{1}{\beta (1+r)} \right)^\sigma (1+r)} $$
\item Example of policy tool: interest rate $r$
\medskip
\item Clearly when $r$ changes, MPC $\gamma$ changes $\Rightarrow$ when interest rates change drastically, may no longer want to use historical MPC estimates
\ei
\end{frame}



\begin{frame}{Lucas' solution = microfoundations}
\vspace{-3mm}
\bi
\item Build models of individual behavior starting from \tr{policy-invariant primitives}
\medskip
\item Which ones? Answer: primitives of classical microeconomics
\bi
\smallskip
\item preferences
\smallskip
\item technology
\smallskip
\item resource constraints
\ei
\medskip
\item This hopefully looks familiar. Precisely why I always make such a big deal out of spelling out these primitives for each economy we study.
\medskip
\item Preference and technological parameters are sometimes called \tr{``structural parameters"} where ``structural" means ``policy-invariant"
\bi
\smallskip
\item examples: discount factor $\beta$, IES $\sigma$
\ei
\medskip
\item To think about: how satisfactory is proposed solution in practice?
\bi
\smallskip
\item If a model is misspecified, can we treat primitives as policy-invariant?
\smallskip
\item Is a model with a representative household really ``microfounded"?
\ei
\ei
\end{frame}



\begin{frame}{Rational expectations}
\vspace{-3mm}
\bi
\item Separate idea often mentioned together with Lucas critique, likely because pushed by same economists (Lucas, Sargent \& co) around same time
\medskip
\item People often use term ``rational expectations revolution"
\bi
\smallskip
\item often (not always) they actually mean push for microfoundations
\ei
\medskip
\item Lucas critique and microfoundations are really the more fundamental \& influential ideas -- ``microfoundations revolution"?
\bi
\smallskip
\setstretch{0.75}
\item Werning on Lucas: {\notsotiny ``Lucas was a visionary not for importing rational expectations into [macro], but for understanding that GE theory was the basis for completely refounding macroeconomics."}
\smallskip
\item Blanchard on Lucas {\tiny\url{https://www.tandfonline.com/doi/full/10.1080/09672567.2022.2137552}}\\
\setstretch{0.75}
{\notsotiny ``[What Lucas did] was to define the rules of what a macro model had to be: It had to be dynamic; it had to have general equilibrium; it had to have optimising agents; then it had to have expectations, in that case rational expectations, but that was not essential."}\\
\smallskip
{\notsotiny ``The widely accepted notion was that macro was different from micro because of aggregation, because of complex behaviour, because of all that. You were inspired by theory, but you surely didn’t feel like you actually had to \tr{derive things from first principles}. And I was always struck by my revered colleague Paul Samuelson, who, when he did micro, did it absolutely rigorously. And when he did macro he just wrote equations down which sounded right, and that was thought to be the only way to go."}
\ei
\ei
\end{frame}


\begin{frame}{Rational expectations}
\bi
\item While we're at it, let's also define ``rational expectations" ... but first need some language
\bi
\medskip
\item stochastic = there is uncertainty, i.e. something is a random variable
\medskip
\item rational = people and firms maximize some objective function
\ei
\bigskip
\item \textbf{\tr{Rational expectations}} = people know the correct probability distributions of stochastic economic variables
\bi
\medskip
\item people's \tr{subjective} probability distributions used to form expectations = \tr{objective} (actual) probability distributions
\ei
\ei
\end{frame}


\begin{frame}{Rational expectations}
\vspace{-3mm}
\bi
\item Example: throwing fair coin
\bi
\medskip
\item rational expectations = people know that Pr(heads) = Pr(tails) = 0.5
\medskip
\item ... use this to compute expected utility $0.5 \times U(\mbox{heads}) + 0.5 \times U(\mbox{tails})$
\ei
\bigskip
\item Rational expectations = same idea but applied to everything, e.g. you know correct probability distribution of everything in entire economy
\bi
\medskip
\item clearly a very strong assumption
\medskip
\item but definitely does not say people always get it right or the like (which is what's sometimes stated in cheap criticisms of economics)
\medskip
\item ``rational expectations" does not imply ``rationality" or vice versa
\medskip
\item better word: ``model-consistent expectations"
\medskip
\item much more controversial than Lucas critique which most economists agree with (though not necessarily with the proposed solution)
\ei
\ei
\end{frame}





\begin{frame}{A Nobel prize for rational expectations \& microfoundations}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=.57\textwidth]{figures/lucas} 
\end{figure}
\vspace{-4mm}
{\scriptsize \url{https://www.nobelprize.org/prizes/economic-sciences/1995/summary/}}
\end{frame}




\begin{frame}{1980s: the Real Business Cycle (RBC) Model}
\vspace{-4mm}
\bi
\item Developed in the 1980s, following the ``rational expectations revolution"
\bigskip
\item The first fully-fledged microfounded business cycle model
\bigskip
\item Key paper by Kydland and Prescott (1982)
\ei
\begin{figure}[tph]
	\centering
\includegraphics[width=.9\textwidth]{figures/kydland-prescott-abstract} 
\end{figure}
\end{frame}


\begin{frame}{Why \tr{Real} Business Cycle Model?}
Reminder: ``nominal" and ``real"
\bi
\medskip
\item Nominal: not adjusted for inflation, i.e. money values
\medskip
\item Real: adjusted for inflation, i.e. quantities valued such that they are comparable over time -- think ``physical" quantities
\ei
\bigskip
Why \tr{real} business cycle model?
\bi
\medskip
\item because money and nominal variables play \tr{no role} in it
\medskip
\item in contrast to Keynesian theories -- see next lecture and your EC1B1 and EC1P1 notes
\ei
\end{frame}








\begin{frame}{A Nobel prize for the RBC model}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=.57\textwidth]{figures/kydland_prescott} 
\end{figure}
\vspace{-4mm}
{\scriptsize \url{https://www.nobelprize.org/prizes/economic-sciences/2004/summary/}}
\end{frame}




\begin{frame}{Reading suggestions for those who like old papers and drama (not examinable)}
\bi
\item Lucas and Sargent (1979) ``After Keynesian Macroeconomics" {\scriptsize \url{https://www.bostonfed.org/-/media/Documents/conference/19/conf19d.pdf}}
\bi
\medskip
\item don't miss discussion by Ben Friedman, Lucas \& Sargent response
\medskip
\item 1978 Boston Fed conference ``After The Phillips Curve" for which paper was written {\tiny \url{https://www.bostonfed.org/news-and-events/events/economic-research-conference-series/after-the-phillips-curve-persistence-of-high-inflation-and-high-unemployment.aspx}}
\medskip
\item ... and Sargent's recollection of conference here {\scriptsize \url{http://www.liuyanecon.com/wp-content/uploads/Sargent-2022.pdf}}
\ei
\bigskip
\item Summers (1991) ``The Scientific Illusion in Empirical Macroeconomics"
{\scriptsize\url{https://www.jstor.org/stable/3440321}}
\ei
\end{frame}







\begin{frame}
\renewcommand{\baselinestretch}{1}
\vspace{3cm}
\begin{center}
{\huge A Two-Period RBC Model}
\end{center}
\end{frame}


\begin{frame}{Model from lecture 5 = baby RBC model}
\bi
\item Key idea of RBC model: (random) variations in productivity (TFP) as source of business cycles
\bi
\medskip
\item changes in productivity drive output, investment, consumption, ...
\ei
\bigskip
\item Solow model emphasized TFP as source of growth
\bigskip
\item .... now emphasize variations in TFP as source of business cycles
\bigskip
\item The model of lecture 5 had exactly these features
\ei
\end{frame}



\begin{frame}{Recall: primitives of baby RBC model}
\bi
\item \tr{\textbf{Preferences:}} households have utility function
$$U(C_1) + \beta U(C_2) \quad \mbox{with} \quad U(C) = \frac{C^{1-\frac{1}{\sigma}}-1}{1-\frac{1}{\sigma}}$$
\item \tr{\textbf{Technology:}} firms have production function
$$Y_t = \tr{A_t} K_t, \quad t=1,2 $$
and capital accumulates according to $K_2 = I_1 + (1-d)K_1$ with $d=1$, i.e.
$$K_2 = I_1 $$
\item \tr{\textbf{Resource constraints (feasibility):}}
\begin{align*}
\mbox{goods in period 1:} \quad &C_1 + I_1 = Y_1\\
\mbox{goods in period 2:} \quad&C_2 = Y_2 
\end{align*}
\ei
\end{frame}



\begin{frame}{Recall: competitive equilibrium allocation}
\vspace{-5mm}
\begin{equation*}\begin{split}
C_1 &= \frac{\left(\frac{1}{\beta A_2} \right)^\sigma A_2}{1+\left(\frac{1}{\beta A_2} \right)^\sigma A_2}A_1 K_1 \\
C_2 &= \frac{A_2}{1+\left(\frac{1}{\beta A_2} \right)^\sigma A_2}A_1 K_1 \\
K_2 = I_1 &= \frac{1}{1+\left(\frac{1}{\beta A_2} \right)^\sigma A_2}A_1 K_1 \\
Y_1 &= A_1 K_1 \\
Y_2 &= \frac{A_2}{1+\left(\frac{1}{\beta A_2} \right)^\sigma A_2}A_1 K_1\\
1+r_1&=A_2
\end{split}
\end{equation*}
\end{frame}



\begin{frame}{Recall: a recession due to a drop in $A_1$ and/or $A_2$}
\be
\medskip
\item When $A_1$ falls, all of $(C_1,C_2,I_1,Y_1,Y_2)$ fall unambigously
\bi
\medskip
\item $C_1$ and $I_1$ both fall because $C_1+I_1=Y_1$ and $Y_1=A_1 K_1$ falls 
\ei
\bigskip
\item When $A_2$ falls and $\sigma<1$, $(C_1,C_2,Y_1,Y_2)$ fall and $I_1$ rises
\bi
\medskip
\item $C_1+I_1=Y_1$ and $Y_1$ unaffected, $\sigma<1 \Rightarrow$ income effect dominates
\ei
\bigskip
\item When both $A_1$ and $A_2$ fall (e.g.  $\log A_2 = \rho \log A_1 + \varepsilon_2$), economic effect is combination of effects in cases 1 and 2
\ee
\end{frame}



\begin{frame}{Oil shocks as productivity shocks (or gas shocks)}
\vspace{-3mm}
\bi
\item What on earth is a drop in productivity? 
\bi
\medskip
\item do we think people forget how to make stuff? Not really
\medskip
\item hard to come up with sensible justifications
\ei
\bigskip
\item One possible justification: oil shocks or energy (gas etc) shocks
\pause
\bigskip
\item Technology: firms use oil to produce
$$\tilde{Y}_t =  \tilde{A}_t K_t^\alpha O_t^{1-\alpha}.$$
\item Firms maximize output net of oil expenditure
$$Y_t = \max_{O_t} \ \tilde{A}_t K_t^\alpha O_t^{1-\alpha} - p_t O_t \quad \mbox{where} \ p_t = \mbox{oil price} $$
$$\Rightarrow \quad Y_t = A_t K_t \ \ \mbox{where} \ \ A_t = \mbox{effective productivity} = \alpha \tilde{A}_t^{1/\alpha} \left(\frac{1-\alpha}{p_t} \right)^{(1-\alpha)/\alpha}  $$
so an increase in $p_t$ causes a drop in effective productivity
\ei
\end{frame}


\begin{frame}{Room for policy in the baby RBC model?}
\bi
\item Suppose we introduce government spending into this model
\begin{align*}
\mbox{goods in period 1:} \quad &C_1 + I_1 + \tr{G_1} = Y_1\\
\mbox{goods in period 2:} \quad&C_2 = Y_2 
\end{align*}
\item Should the government engage in countercyclical fiscal stimulus, i.e. increase $G_1$ if there is a recession (due to a fall in $A_2$)?
\bigskip
\item Why or why not?
\bigskip
\item How does this compare with policy prescriptions of the Keynesian model?\\
\bigskip
\item What about other policies, e.g. investment subsidies, income taxes, ...?
\bigskip
\item What about monetary policy?
\ei
\end{frame}


\begin{frame}
\renewcommand{\baselinestretch}{1}
\vspace{3cm}
\begin{center}
{\huge The Fully-Fledged RBC Model}
\end{center}
\end{frame}



\begin{frame}{Primitives of the RBC model}
\vspace{-3mm}
\bi
\item Relative to baby RBC model: infinite horizon, uncertainty, labor supply
\bi
\smallskip
\item a ``dynamic stochastic general equilibrium (DSGE) model"
\ei
\medskip
\item \tr{\textbf{Preferences:}} households have utility function
\vspace{-2mm}
$$U(C_0,N_0) + \beta \mathbb{E}[U(C_1,N_1)] + \beta^2 \mathbb{E}[U(C_2,N_2)] + ... = \mathbb{E}\sum_{t=0}^\infty \beta^t U(C_t,N_t) $$
Note: expectation $\mathbb{E}[\cdot]$ because $C_t$ and $N_t$ are stochastic (because $A_t$ is)
\medskip
\item \tr{\textbf{Technology:}} firms have production function
$$Y_t = \tr{A_t} F(K_t,N_t), \quad t=1,2,... $$
where \tr{$A_t$ is stochastic} (see next slide), capital accumulates according to
$$K_{t+1} = I_t + (1-d)K_t, \quad 0<d<1$$
\item \tr{\textbf{Resource constraints (feasibility):}}
\begin{align*}
\mbox{goods in period t:} \quad C_t + I_t = Y_t, \quad t=1,2,... 
\end{align*}
\ei
\end{frame}


\begin{frame}{Evolution of the Technology}
\bi
\item $A_{t}$ changes randomly over time
\bi
\medskip
\item ignore growth and just think of fluctuations around a trend
\ei
\bigskip
\item Assume $A_t$ follows the process:
$$\log A_{t} = \rho \log A_{t-1}+\varepsilon_{t}, \qquad \varepsilon_{t} \sim \mathcal{N}(0,\sigma^2)$$
where $\varepsilon_{t} \sim \mathcal{N}(0,\sigma^2)$ means $\varepsilon _{t}$ is normally distributed w mean 0, var $\sigma^2$
\bigskip
\item This process is called $AR(1)$ process: ``autoregressive of order 1"
\bigskip
\item The parameter $\rho$ governs persistence of changes in TFP
\bi
\medskip
\item if $\rho=1$ they are permanent
\medskip
\item if $0<\rho<1$ they are persistent but eventually die out
\ei
\ei
\end{frame} 


\begin{frame}{Examples of TFP Processes}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=.7\textwidth]{figures/TFP_processes.pdf} 
\end{figure}
\end{frame} 




\begin{frame}{Logic of RBC model: response to positive TFP shock}
\vspace{-3mm}
\bi
\item Static effects of positive TFP shock:
\bi
\smallskip
\item implies higher labor productivity, increasing wages
\smallskip
\item substitution effect leads to higher labor supply, thus increasing output
\ei
\medskip
\item Dynamic effects of positive TFP shock:
\bi
\smallskip
\item part of increased output is consumed, but part is saved
\smallskip
\item the more persistent the shock, the more is saved
\smallskip
\item return to capital $\uparrow \Rightarrow$ investment $\uparrow \Rightarrow$ capital stock $\uparrow$
\ei
\medskip
\item So for extended period: greater output due to labor, capital $\uparrow$ (plus TFP $\uparrow$)
\bi
\smallskip
\item effects of single shock eventually die out, but they may be long-lived
\smallskip
\item new shocks continually arrive
\ei
\medskip
\item Two key features of RBC model
\be
\smallskip
\item amplification: small shocks generate large cycles 
\smallskip
\item persistence: transitory shocks generate persistent cycles
\ee
\ei
\end{frame}


\begin{frame}{Small, transitory shocks generate large, persistent cycles}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=.9\textwidth]{figures/abel_bernanke.pdf} 
\end{figure}
\end{frame} 






\begin{frame}{Room for policy in the RBC model?}
\bi
\item No, because 1st welfare theorem holds
\bigskip
\item Same logic as in baby RBC model
\bigskip
\item In RBC model, business cycles are efficient
\bi
\medskip
\item the optimal response to a changing environment
\medskip
\item  when productivity falls, it's a bad time to produce, so households \tr{should} work and invest less
\medskip
\item government intervention can only worsen the allocation
\ei
\bigskip
\item For more discussion, see Kurlat, chapter 13.5, section ``Policy Implications"
\bigskip
\item Come back to this at end of lecture
\ei
\end{frame}



\begin{frame}
\renewcommand{\baselinestretch}{1}
\vspace{3cm}
\begin{center}
{\huge Criticims of the RBC Model}
\end{center}
\end{frame}


\begin{frame}{Criticisms of the RBC model}
See the good discussion in Kurlat, chapter 13.5, section ``Criticisms"
\be
\bigskip
\item Mechanism for generating recessions not plausible (see next slides)
\bigskip
\item Need implausible parameter values, in particular implausibly high labor supply elasticity
\bigskip
\item Model fits cyclical behavior of quantitities but not of prices (real wages and interest rates)
\bigskip
\item Model does not feature any unemployment
\bigskip
\item Inappropriate to treat measured TFP (Solow residuals) as productivity shocks, e.g. due to mismeasured capacity utilization
\ee
\end{frame}


\begin{frame}{A hostile description of the RBC model (part 1)}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=\textwidth]{figures/RBC_criticism1} 
\end{figure}
Source: {\scriptsize \url{http://bactra.org/notebooks/dsges.html}} by Cosma Shalizi (statistician) 
\end{frame}


\begin{frame}{A hostile description of the RBC model (part 2)}
\vspace{-4mm}
\begin{figure}[tph]
	\centering
\includegraphics[width=\textwidth]{figures/RBC_criticism2} 
\end{figure}
Source: {\scriptsize \url{http://bactra.org/notebooks/dsges.html}} by Cosma Shalizi (statistician) 
\end{frame}


\begin{frame}{A hostile description of the RBC model: brief discussion}
\vspace{-3mm}
\bi
\item To be clear: this description is basically correct
\bigskip
\item But it is a bit unfair in that it somewhat misunderstands how economists think about models  -- see ``Modeling in (Macro)economics" in Lecture 1
\bi
\smallskip
\item ``descriptive realism is not the objective"
\smallskip
\item idea of ``crucial" or ``critical" assumptions
\smallskip
\item ``Do not criticize an economist’s model because of its assumptions; ask how the results would be changed if the assumptions that seem problematic were more realistic."
\ei
\bigskip
\item I nevertheless like and teach this hostile description because 
\bi
\medskip
\item it's pretty funny
\medskip
\item some of these assumptions do turn out to be ``crucial" assumptions
\medskip
\item ... i.e. when assumptions are made more realistic, results change, in particular policy implications
\ei
\ei
\end{frame}


\begin{frame}{Key takeaways from RBC model (my opinion)}
\be
\item RBC model makes one pretty deep point: \tr{Just because something fluctuates doesn't mean it's necessarily inefficient}
\bi
\medskip
\item forces us to ask harder questions
\medskip
\item any argument for trying to stabilize the business cycle must first make the case of why such stabilization is desirable
\medskip
\item an application of what we said in Lecture 2: 1st welfare theorem forces us to think about rationale for policy intervention -- what market failures, frictions, externalities are there?
\ei
\bigskip
\item Methodologically, RBC model shows how a simple model can generate amplification and persistence
\ee
\end{frame}






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