Are real business cycles dead?

Aim: This paper aims to assess whether technological changes and resource availability are the primary drivers of business cycles, as suggested by the Real Business Cycle (RBC) theory, and propose a suitable monetary policy response to shocks. If business cycles are a result of technological changes and the availability of resources, monetary management is often not desirable. Methodology: The authors developed a standard RBC model from the class of DSGE models and then extended it by incorporating capital utilisation to enhance the model’s realism. A step-by-step derivation of the model's equilibrium conditions is also presented, whilst the model was calibrated using US data and solved in Matlab and Dynare. Results: The results showed that the inclusion of capital utilisation substantially amplified the impact of productivity shocks, so that even a relatively small total factor productivity shock generated realistic fluctuations in output. Implications and recommendations: The findings suggest that monetary and fiscal authorities have limited scope to smooth fluctuations arising from supply shocks, and that excessive policy intervention may be counterproductive. Therefore, RBC models could serve as a useful tool for policymakers as it shows that government and monetary management are often not desirable. Future research could enrich the model through labour market heterogeneity, investment frictions, and open economy features. Originality/value: The results are in contrast with the conclusions of earlier literature, which typically found that only large technology shocks are capable of producing such dynamics. The main added value of the paper results from the extension of the standard RBC framework through the incorporation of capital utilisation.