Real business cycle theory
Also called: RBC theory · Topic: Schools of Economic Thought and Economic Laws · NCERT: Beyond NCERT
Meaning
Real business cycle (RBC) theory was developed by Finn Kydland and Edward Prescott (1982). It says booms and slumps are the economy's efficient response to real shocks, meaning changes in what the economy can actually produce, such as new technology or changes in productivity. In this view, a recession is not a failure of demand. It is people and firms sensibly adjusting to a worse situation. So active government policy to smooth the cycle is not needed, and may do harm. Kydland and Prescott won the Nobel in 2004.
Example
Suppose a new technology sharply raises productivity. Firms produce more and workers choose to work more, so a boom follows. When productivity growth slows, output falls. RBC theory sees both phases as efficient adjustments, not problems that stimulus spending must fix.
Don't confuse with
- New Keynesian economics: it says cycles often come from swings in demand, and that sticky prices and wages make them costly and inefficient. So it supports stabilisation policy.
Related concepts
- Monetarism
- Chicago school
- Cantillon effect
- Adaptive expectations
- Rational expectations
- Lucas critique
- Tinbergen rule
- Austrian school
- Economic calculation problem
- Supply-side economics