Critically assess the real business cycle explanation of unemployment. How strong is the evidence in favor of this approach? 1. Introduction The analysis of the performance of economies can offer significant information on their potentials to face unexpected market turbulences…
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The review of the literature published in the specific field has led to the following assumption: RBC theory can be used for understanding critical aspects of economies but the performance of theory in different market conditions is not standardized. It has been also proved that the evidence against the theory is significant, implying that many of its points should be reviewed as of their validity and accuracy. In any case, it seems that the weaknesses of the specific theory are many, as analyzed through the paper, so that its benefits cannot efficiently support its value as a theoretical tool for explaining one or more elements of modern economies. 2. Real business cycle explanation of unemployment – description and evaluation Unemployment is a critical part of the economy, at the level that it helps to evaluate the performance of the economy, either in the short or the long term. Economies with low unemployment rates are usually characterized as successful, even if the relevant trends are just temporary, an issue analyzed below. Also, it can help to estimate the potential value of measures taken for supporting the performance of an economy: if unemployment trends remain high despite the introduction of measures for increasing GDP in a specific country, then the introduction of different approaches for supporting the local economy is made clear. In order to understand the effectiveness of the Real business cycle in explaining unemployment it would be necessary to present primarily the general framework of the concept, i.e. its core characteristics and parts. Then the use of the theory for explaining unemployment can be evaluated by referring to the existing evidence with reference especially to the approaches against RBC. 2.1 Real business cycle explanation of unemployment as a theoretical concept The real business cycle (RBC) theory, known also as the real business cycle models, was first introduced in 1980s for replacing the New Classical models (Gottschalk 2005). Like their predecessor, the RBC theory aimed to explain the ‘business cycle fluctuations’ (Gottschalk 2005, p.100), as resulted not from monetary events (a view used by the New Classical models for explaining business cycle fluctuations), but rather from real events. In this context, the RBC theory has been based on the rule that business cycle fluctuations are best explained by referring to ‘real shocks’ (Gottschalk 2005, p.100), such as ‘changes in technology or government spending’ (Gottschalk 2005, p.100). In accordance with Snower and Dehesa (1997) the RBC theory is based on the following rule: ‘macroeconomic fluctuations tend to be related to technological shocks’ (Snower and Dehesa 1997, p.19), meaning that each such shock is likely to be followed by microeconomic fluctuations, either in the short or the long term. From this point of view, those people that are best prepared to face such shocks are most capable of surviving in the job market, being able to respond immediately to the relevant market demands. Because of the continuous changes in market conditions due to the intervention of ‘real events’, or else of ‘real shocks’, the RBC theory h
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