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# Correlation 1.0 0.9 0.8 0.?

As we can see from the graphic below, the simulated real business cycle (RBC) model fits real world data quite well with the exception of average labor productivity (the bars on the far right hand side of the graphic). In particular, the real world data suggests that average labor productivity is weakly pro-cyclical with the correlation between average labor productivity and output between 0.3 and 0.4. The simulated correlation from the RBC model over 0.8, clearly not consistent with the facts. Given these results, we say that the simulated RBC model implies that average labor productivity is more pro-cyclical than it actually is.

We then argued that when we add fiscal (Government spending) shocks to the RBC model, this ” average labor productivity is too pro-cyclical” problem is lessoned since the theory implies that in a fiscal shock world, all else constant, average labor productivity tends to be slightly counter-cyclical. In the space below, explain in detail how average labor productivity is slightly counter-cyclical in a “fiscal shock” world. Be sure to support your arguments with a labor market diagram and a production function labeling the initial equilibrium (before the fiscal shock) as point A and the subsequent equilibrium (after the fiscal shock) as point B. Be sure to explain exactly why workers and firms change their behavior given the fiscal shock.Comment on how the RBC theorists felt about discretionary counter-cyclical fiscal policy and why (i.e., “hands off” or “hands on?”).

Correlation 1.0 0.9 0.8 0.? 0.5 05 0A 0.3 0.2 0.1 0.0 ReaEGNF Consumption Investment – ActualSimulated usin- 9 the REC model inventory Total hours Productivity stocks worked Variable

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