Real Business Cycles

Chapter 4Theory Ahead of Business Cycle Measurement^*

Federal Reserve Bank of Minneapolis Quarterly Review 10(4), Fall 1986, pp. 9-22.

Edward C. Prescott Advisor Research Department Federal Reserve Bank of Minneapolis and Professor of Economics University of Minnesota

Economists have long been puzzled by the observations that during peacetime industrial market economies display recurrent, large fluctuations in output and employment over relatively short time periods. Not uncommon are changes as large as 10 percent within only a couple of years. These observations are considered puzzling because the associated movements in labor’s marginal product are small.

These observations should not be puzzling, for they are what standard economic theory predicts. ...