EC201 Macroeconomics 2, Spring 2016

University of Warwick
Thijs van Rens

Business Cycles
Seminar questions - part II

Simulating the RBC model Last week, you derived the equilibrium conditions
of the RBC model.
u0 (ct ) =

(1 + At+1 f1 (Kt+1 ; ht+1 )

) u0 (ct+1 )

v 0 (1 ht )
= At f2 (Kt ; ht )
u0 (ct )
Kt+1 = (1

) Kt + At f (Kt ; ht )

ct

This week, we will simulate this model using the computer. We will then evaluate how
the predictions of the model compare to real-world data. We will also think about
what the model implies about the welfare costs of business cycles.
1. What are the parameters of this model? Describe briey how these are usually
calibrated. Are there any parameters that you would calibrate dierently.
2. We will start to analyze the predictions of the model by calculating the steady
state. Derive three equations that characterize steady state consumption c,
capital K and hours worked h. Assume utility is logarithmic over consumption,
u (ct ) = ln ct , and the production function is the usual Cobb-Douglas function,
At Kt h1t . For simplicity, you may also assume = 0.1 Calculate an (implicit)
expression for steady state hours worked in terms of parameters and exogenous
variables only.
3. What is the eect of a technological improvement, i.e. an increase in At on
hours worked in steady state? What is the intuition for this result? Do you
think this is a realistic prediction of the model? Why (not)?
4. We now proceed to characterize the solution of the fully dynamic model. What
form does the solution of the model take? How could we describe this solution
so that we can meaningfully compare it to the data?
5. (optional) Simulate the models solution on the computer. You will nd the
Matlab codes to do this on the module website and a brief instruction for using
these codes below. If you do not have acces to Matlab or you are not interested
to try this yourself, you may skip this part and directly refer to the output in
Table 1 below.
6. Interpret the numbers in Table 1? Explain briey how these numbers are calculated and what each entry in the table means.
1
If you do not want to make this assumption, you do not need to. Your answer to part 3 below
will be the same result, but the math will be a bit more involved.

7. How do the predictions of the model compare to the data? What are the main
successes of the model? What are the main failures?
8. How does your answer to part 2 above help us understand the empirical performance of the model?
9. The last row in Table 1 presents business cycles statistics for the period utility
of the representative household. The utility function I used here is u (ct ) +
v (1 ht ) = ln ct + ln (1 ht ) + 10. There is nothing deep about the +10 term,
it merely prevents utility from becoming negative so that its logarithm is welldened, which is necessary for the code to run. Using this row and any other
entries in the table you may need, calculate the cost of business cycles in this
model. As is common, you should express this cost in terms of a sacrice of
average consumption.
10. To make sure we are doing things right, Table 2 again simulates the model, but
with shocks that are 10 times larger. Make sure you understand the dierences
between Tables 1 and 2 and then again calculate the cost of business cycles.
How does this cost compare to that in the previous part?
11. What do the above results teach us about business cycles? What do they teach
us about the RBC model?

Brief instructions for Dynare for Matlab On the course website, you will nd
Matlab programs that solve the RBC model and simulate data from it, using Dynare.
The model is calibrated as in King and Rebelo (1999). The code also summarizes the
simulated data in terms of the usual business cycle statistics.
1. On a computer that has Matlab installed, go to www.dynare.org and install
Dynare for Matlab. Remember the directory where you installed the les. You
may also want to download the user guide and/or reference manual.
2. In Matlab, set the path to include the matlab subdirectory in the dynare folder
(go to File - Set Path - Add folder). To verify installation, type help dynare at
the Matlab command prompt.
3. Copy the les from the course website into your working directory and open the
les rbcsimul.m and rbcmodel.mod in the Matlab editor (the remaining les,
hplter.m, penta2.m and table.m, are auxilliary les and are not of interest
here). At the command prompt, type rbcsimul and check the code runs correctly.
4. You may now modify the code to use it to solve and simulate dierent models.
For more information, you will nd a user guide, a tutorial and a reference manual for Dynare online at http://www.dynare.org/documentation-and-support.
Table 1. Business cycle statistics for the RBC model
VARIABLE
c
h
K
i
y
A
util

ST.STATE
0.4391
0.1936
4.4452
0.1111
0.5502
1.0000
8.9618

MEAN
0.4390
0.1936
4.4456
0.1116
0.5503
0.9998
8.9606

STD.DEV.
0.0061
0.0068
0.0042
0.0472
0.0140
0.0094
0.0005

REL.S.D.
0.4344
0.4899
0.2970
3.3801
1.0000
0.6720
0.0382

AUTOCORR
0.7895
0.7100
0.9588
0.7118
0.7262
0.7226
0.8363

CORR.Y
0.9435
0.9715
0.3895
0.9857
1.0000
0.9995
0.8645

Table 2. Business cycle statistics for the RBC model with large shocks
VARIABLE
c
h
K
i
y
A
util

ST.STATE
0.4391
0.1936
4.4452
0.1111
0.5502
1.0000
8.9618

MEAN
0.4899
0.1951
5.2047
0.1905
0.6371
1.0524
8.9616

STD.DEV.
0.0607
0.0684
0.0415
0.4722
0.1397
0.0939
0.0053

REL.S.D.
0.4344
0.4899
0.2970
3.3801
1.0000
0.6720
0.0382

AUTOCORR
0.7895
0.7100
0.9588
0.7118
0.7262
0.7226
0.8363

CORR.Y
0.9435
0.9715
0.3895
0.9857
1.0000
0.9995
0.8645