Real Business Cycle Theory

Real business cycle theory isn’t your Grandpa’s economics (if your Grandpa’s economics is Keynesian economics, that is). It’s a part of new classical macroeconomics, and is associated with “freshwater economics,” which challenges the macroeconomic status quo that is Keynesian economics.

Real business cycle theory says that business cycle fluctuations are a result of real shocks, not nominal effects. It purports that the cyclical nature of the market is an efficient market response in the long-run, even if it’s a bit unpleasant in the short-run.

Real business cycle theory sees Keynesian government intervention through fiscal and monetary policy as reactionary, only focusing on short-term effects, when they could be looking at structural changes that would impact the long-term. Time will tell if real business cycle theory makes a comeback as business cycles get more and more dramatic (hello, 2008).