Keynes vs. Prescott and Solow: Identifying Sources of Business Cycle Fluctuations

Who was closer to the source of business cycle fluctuations--Keynes or Prescott and Solow? Two types of business-cycle impulses which have been associated with their names -- marginal efficiency of investment shocks (Keynes) and technology shocks (Prescott and Solow) -- are studied here in a neoclassical model which builds on the Greenwood, Hercowitz, and Huffman (1988) variable-utilization framework. The important parameters of the model are estimated using a Bayesian procedure which accommodates prior uncertainty about their magnitudes; from these estimates, posterior distributions of the two shocks are obtained. The postwar U.S. experience suggests that both shocks are important in understanding fluctuations, but that investment shocks are primarily responsible for beginning and ending recessions. * The University of Pittsburgh ** The University of Iowa