Indeterminacy in real business cycle models

Abstract

The baseline real business cycle (RBC) model is a stochastic optimal growth model with flexible labor supply. The typical driving force of business fluctuations is a technological shock hitting the total factor productivity (TFP) of the aggregate economy in each period. In RBC models with equilibrium determinacy, the economy never fluctuates in response to non-fundamental shocks that only affect expatiations of households and firms. As discussed in the previous chapter, the necessary condition for the existence of sunspot-driven business cycles is that the equilibrium path of the economy is indeterminate.