An old joke about Real Business Cycles is that they assume recessions are caused by technological regress. Without other frictions, the only way for an economy to get lower output given the installed capital and the number of workers is to have a sudden drop in productivity of those inputs.
Well, who in the hell ever heard of a technological regression? What, did people forget how make stuff? lose the blueprint? Ha ha ha… those stupid RBC theorist. What a bunch of mathematical masturbation!
Ahem. Well, here are three examples of technological regress. First, the financial mess can be seen as throwing sand in the works. Its harder to get working capital — if your bank is skittish you have to walk down the street to get your loans from somewhere else — so production is more expensive. Second, here’s Willem Buiter entertainingly complaining about centralization causing technological regress. Third, an increase in distortions in the finance sector where it is harder for some sectors to get financing can *look* like technological regress.
The last point was explained by Prof. Kehoe at the loooooooooooooong session on monetary policy at the AEA meetings (see day two part 1). He shows a simple single sector growth model with plain vanilla productivity shocks (i.e. technological regress) is observational equivalent to a more sophisticated two sector model with sector specific labor costs (e.g. costs in working capital). The more sophisticated model tells a story for why there is “technological regress” but it doesn’t necessarily tell us more about the economy. For that, the model would need to generate other testable predictions.
The RBC literature found “technological shocks” were important for explaining business cycles. Many, perhaps more conservative, economists took this result literally… variation in stuff policy makers have no control over, namely exogenous technology, cause business cycles so policy can’t help smooth cycles. For this literal interpretation of “technology shocks” those economists were rightly ridiculed, but the lesson of RBC models is exactly what it should be: these models identified a fundamental cause of business cycles and they pointed the way to a deeper understanding. To understand business cycles, we need to understand “technological shocks”. RBC models aren’t wrong; they’re just not right enough.