Two Flaws in Business Cycle Accounting

67 Pages Posted: 1 Nov 2006

See all articles by Lawrence J. Christiano

Lawrence J. Christiano

Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Joshua Mark Davis

Northwestern University - Department of Economics; Pacific Investment Management Company (PIMCO)

Multiple version iconThere are 2 versions of this paper

Date Written: October 18, 2006

Abstract

Using 'business cycle accounting' (BCA), Chari, Kehoe and McGrattan (2006) (CKM) conclude that models of financial frictions which create a wedge in the intertemporal Euler equation are not promising avenues for modeling business cycle dynamics. There are two reasons that this conclusion is not warranted. First, small changes in the implementation of BCA overturn CKM's conclusions. Second, one way that shocks to the intertemporal wedge impact on the economy is by their spillover effects onto other wedges. This potentially important mechanism for the transmission of intertemporal wedge shocks is not identified under BCA. CKM potentially understate the importance of these shocks by adopting the extreme position that spillover effects are zero.

Keywords: business cycle accounting, real business cycles, identification, maximum likelihood

JEL Classification: C0, C32, C52

Suggested Citation

Christiano, Lawrence J. and Davis, Joshua Mark and Davis, Joshua Mark, Two Flaws in Business Cycle Accounting (October 18, 2006). FRB of Chicago Working Paper No. 2006-10, Available at SSRN: https://ssrn.com/abstract=941171 or http://dx.doi.org/10.2139/ssrn.941171

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