RBC and NK Models

Bruce Bartlett and Mark Thoma take on the conflict arena between the Real Business Cycle (RBC) model and the New Keynesian (NK) model. Bruce sketches out his concept of the difference, and Mark brings more of an in-depth analysis to the subject, while disagreeing with Bruce’s basic conclusion. Both accept that the natural rate of Output is subject to Supply shocks, but Mark goes on to assert that Actual Output is affected by both Demand and Supply shocks. Study Mark’s analysis closely as it probably relates most closely to the commonly held beliefs in the economic profession.

My problem resides with the exact definition of Supply shocks. Both Bruce and Mark imply that while Supply shocks are natural, they should somehow be reduced by Public policy. Supply shocks are a natural condition, the result of process of business development; a process of investment followed by a recoupment of financial reserves (a Period of Marketing distribution to make initiated Production profitable). Artificial supplement of these financial reserves through favorable tax rates dissipates Business energy from optimum organization of Production and Marketing to maximize Profitability, and directs Business interest into new Production modes before the ‘bugs’ of the older Production have been worked out. You can definitely place me outside the Supply-Side spectrum.

I have equally as much trouble with the NK model, knowing that artificial pressure on Demand generates Inflation more than it does efficient Production. The Fed currently finds itself in the Prisoner’s dilemma of Interest rates set too high, but unable to lower them for proper business performance, solely because of excess Demand created by low tax rates; the Fed cannot lower Interest rates without Inflation, without an increase in tax rates to absorb the excess funds in the economy. Demand shocks serve a very necessary function of distributing mal-allocated financial reserves through the drop in Demand. Readers may possibly not understand the last Sentence; simply revert to the loss of position Wages has sustained in the last years–a percentage of total Income below traditional levels. I am not saying there is too much financial funding of Capital ventures in this Country, I am saying there is too much funding of Investment in this Country in light of insufficient financial fuel for Consumption. I am afraid I cannot accept either of the RBC or NK arguments, or even a blend of them. lgl