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Two flaws in business cycle accounting

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  • Lawrence J. Christiano
  • Joshua M. Davis

Abstract

Using ?business cycle accounting? (BCA), Chari, Kehoe and McGrattan (2006) (CKM) 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 BCA overturn CKM?s conclusions. Second, one way that shocks to the intertemporal wedge impact on 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 BCA. CKM potentially understate the importance of these shocks by adopting the extreme position that spillover effects are zero.

Suggested Citation

  • Lawrence J. Christiano & Joshua M. Davis, 2006. "Two flaws in business cycle accounting," Working Paper Series WP-06-10, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhwp:wp-06-10
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    More about this item

    Keywords

    Accounting; Business cycles;

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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