Real business cycle theory
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Real business cycle theory (RBC theory) are a class of macroeconomic models in which business cycle fluctuations to a large extent can be accounted for by real (in contrast to nominal) shocks. Unlike other leading theories of the business cycle, RBC theory sees recessions and periods of economic growth as the efficient response to exogenous changes in the real economic environment. That is, the level of national output necessarily maximizes expected utility, and government should therefore concentrate on long-run structural policy changes and not intervene through discretionary fiscal or monetary policy designed to actively smooth out economic short-term fluctuations. According to RBC theory, business cycles are therefore "real" in that they do not represent a failure of markets to clear but rather reflect the most efficient possible operation of the economy, given the structure of the economy. RBC theory differs in this way from other theories of the business cycle such as Keynesian economics and Monetarism that see recessions as the failure of some market to clear. RBC theory is associated with freshwater economics (the Chicago school of economics in the neoclassical tradition).
Business cycles
If we were to take snapshots of an economy at different points in time, no two photos would look alike. This occurs for two reasons: 1. Many advanced economies exhibit sustained growth over time. That is, snapshots taken many years apart will most likely depict higher levels of economic activity in the later period. 2. There exist seemingly random fluctuations around this growth trend. Thus given two snapshots in time, predicting the latter with the earlier is nearly impossible.
Real business cycle theory
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A common way to observe such behavior is by looking at a time series of an economy’s output, more specifically gross national product (GNP). This is just the value of the goods and services produced by a country’s...