Two Flaws in Business Cycle Dating
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
Pacific Investment Management Company (PIMCO); Northwestern University - Department of Economics
FRB of Cleveland Working Paper No. 06-12
Using "business cycle accounting," Chari, Kehoe, and McGrattan (2006) 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 business cycle accounting overturn Chari, Kehoe, and McGrattan's conclusions. Second, one way that shocks to the intertemporal wedge affect 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 business cycle accounting. Chari, Kehoe, and McGrattan potentially understate the importance of these shocks by adopting the extreme position that spillover effects are zero.
Number of Pages in PDF File: 62
Keywords: business cycle accounting, financial frictions, intertemporal wedge, spillover effects
JEL Classification: E32, E33
Date posted: October 19, 2007
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