62 Pages Posted: 19 Oct 2007
Date Written: October 2006
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.
Keywords: business cycle accounting, financial frictions, intertemporal wedge, spillover effects
JEL Classification: E32, E33
Suggested Citation: Suggested Citation
Christiano, Lawrence J. and Davis, Joshua Mark, Two Flaws in Business Cycle Dating (October 2006). FRB of Cleveland Working Paper No. 06-12. Available at SSRN: https://ssrn.com/abstract=1022188 or http://dx.doi.org/10.2139/ssrn.1022188