In this paper I review the contribution of real business cycles models to our understanding of economic fluctuations, and discuss open issues in business cycle research.

Diverse beliefs is an important mechanism for propagation of fluctuations, money non neutrality and efficacy of monetary policy. Since expectations affect demand, our theory shows economic fluctuations are mostly driven by varying demand not supply shocks. Using a competitive model with flexible prices in which agents hold Rational Belief (see Kurz (1994)) we show that (i) our economy replicates well the empirical record of fluctuations in the U.S. (ii) Under monetary rules without discretion, monetary policy has a strong stabilization effect and an aggressive anti-inflationary policy can reduce inflation volatility to zero. (iii) The statistical Phillips Curve changes substantially with policy instruments and activist policy rules render it vertical. (iv) Although prices are flexible, money shocks result in less than proportional change in inflation hence aggregate price level is “sticky ” with respect to money shocks. (v) Discretion in monetary policy adds a random element to policy and increases volatility. The impact of discretion on the efficacy of policy depends upon the structure of market beliefs about future discretionary decisions. We study two rationalizable beliefs. In one, market beliefs weaken the effect of policy and in the second, beliefs bolster policy outcomes and discretion could be a desirable attribute of the policy rule. Since the central bank does not know any more than the private sector, discretion is beneficial only in extraordinary cases. Hence, the weight of the argument suggests that policy should be transparent and abandon discretion except for rare

We show diverse beliefs is an important propagation mechanism of fluctuations, money non neutrality and efficacy of monetary policy. Since expectations affect demand, our theory shows economic fluctuations are mostly driven by varying demand not supply shocks. Using a competitive model with flexible prices in which agents hold Rational Belief (see Kurz (1994)) we show that (i) our economy replicates well the empirical record of fluctuations in the U.S. (ii) Under monetary rules without discretion, monetary policy has a strong stabilization effect and an aggressive anti-inflationary policy can reduce inflation volatility to zero. (iii) The statistical Phillips Curve changes substantially with policy instruments and activist policy rules render it vertical. (iv) Although prices are flexible, money shocks result in less than proportional changes in inflation hence the aggregate price level appears “sticky ” with respect to money shocks. (v) Discretion in monetary policy adds a random element to policy and increases volatility. The impact of discretion on the efficacy of policy depends upon the structure of market beliefs about future discretionary decisions. We study two rationalizable beliefs. In one case, market beliefs weaken the effect of policy and in the second, beliefs bolster policy outcomes and discretion could be a desirable attribute of the

The report presents the development of the first composite and diffuse index of leading indicators (CLI, DLI) for Slovene economy. To construct a forecasting model it is necessary to select an indicator of economic activity, as well as a group of variables that, when adjusted construct the CLI and DLI that forecast the reference series. We are developing a model, where NBER method is modified with elements of Stock-Watson approach. Current results suggest, that in the period from 1992 to 2002, CLI and DLI forecasted all turning points of aggregate economic activity. The average lead-time is 8 months, which is comparable with the performance of leading indicators in other countries. There are, however, numerous structural changes going on in Slovenia and such composite leading indicator should be closely followed and re-estimated as more data becomes available in order to capture ongoing changes in transition process.

The Center for Financial Studies is a nonprofit research organization, supported by an association of more than 120 banks, insurance companies, industrial corporations and public institutions. Established in 1968 and closely affiliated with the University of Frankfurt, it provides a strong link between the financial community and academia. The CFS Working Paper Series presents the result of scientific research on selected topics in the field of money, banking and finance. The authors were either participants in the Center´s Research Fellow Program or members of one of the Center´s Research Projects. If you would like to know more about the Center for Financial Studies, please let us know of your interest.

First-order approximation methods are a standard technique for analyzing the local dynamics of dynamic stochastic general equilibrium (DSGE) models. Although linear methods yield quite accurate solutions for a broad class of DSGE models, some important economic issues (e.g., portfolio choice and welfare) cannot be adequately addressed by first-order methods. This paper provides yet another case when first-order methods may be inadequate for capturing the business cycle properties of a DSGE model. In particular, the authors show that increasing returns to scale (due to production externalities) may induce asymmetric business cycles and nonlinear income effects that are not fully captured by linear approximation methods. For example, hump-shaped output dynamics can emerge even when externalities are below the threshold level required for indeterminacy, and output expansion tends to be smoother and longer, whereas contraction tends to be deeper but shorter-lived, as observed in the U.S. economy. (JEL C63, E0, E32) Federal Reserve Bank of St. Louis Review, May/June 2011, 93(3), pp. 187-205. The standard approach to studying the business cycle implications of dynamic stochastic general equilibrium (DSGE)

www.cardiff.ac.uk/carbs

The household sector produces human capital investment sector, which is subject to shocks along with the goods sector, whereby the shock causes growth to temporarily rise, but permanent income levels to rise permanently. This causes consumption to move more with respect to income because permanent income is ‡uctuating by more than in exogenous growth RBC models. This helps solve the central RBC consumption-output puzzle while capturing US data’s output growth persistence, with hump-shaped impulse responses; hump-shaped physical capital investment impulse responses; and Gali’s (1999) negative impulse response of labour supply plus hours volatility. Intuitively the identical two-sector productivity shock causes Rybczynski (1955) and Stolper and Samuelson (1941) e¤ects that release leisure time and initially raise the relative price of human capital investment so as to favor it at …rst over goods production, with this reversing as the cycle progresses.