What is Real Business Cycle model? How is it different from the Keynesian model? Role in DSGE model?

Real business cycle model is based on business cycles and incorporates technological shock as the prime reason for fluctuation in economic activity. Money is neutral with no impact on real variables. 

These models hold the view that fluctuations in aggregate economic activity are an antidote to the uncertainty in agents’ environment arising from exogenous technology shocks. The associated policy implications are clear: there should be laissez-faire policy as any sort of government intervention will reduce total welfare.

Business cycles have the following characteristics:

Firstly, components of aggregate demand i.e. consumption, investment, and employment fluctuate over the period of time. Real wage is comparatively sticky.

Secondly, the effect of temporary shocks on output is highly persistent. The effect of temporary shocks lasts up to eight quarters, with a peak in the fourth or fifth quarter.

Thirdly, consumption is more stable relative to output, than investment.

How it is different from Keynesian Models?

The RBC models assume Walrasian markets and they attribute business cycles primarily to technology ( productivity/real/ supply side) shocks. Supply side shock as the prime reason for the business cycles.

The Keynesian models on the other hand assume fluctuations in aggregate demand due to  imperfect markets with nominal rigidities.

Want to know about DSGE models? Click here

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