Working Paper 01-5
by Daniel G. Swaine

Lucas (1976) criticized Keynesian models because of parametric instability. For many economists, the “Lucas critique” provided a reason to replace the Keynesian approach with equilibrium models of the business cycle. One example of the equilibrium approach is the Real Business Cycle (RBC) model. However, RBC models have not been subjected to the same scrutiny of tests of parameter instability. We present a prototypical RBC model and subject it to structural change tests. Our results document evidence of extensive parameter instability. Thus, the “Lucas critique” is applicable and we conclude that the single representative agent class of RBC models has an invalid structural form.

This paper was revised in March 2002.

JEL classification codes: C32, E1, E13, E32

Keywords: business cycles, real business cycle models, neoclassical growth model, stochastic growth models

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