Working Paper 625

Business Cycle Accounting

Ellen R. McGrattan | Consultant
Patrick J. Kehoe | Stanford University, University College London, Federal Reserve Bank of Minneapolis
V. V. Chari | Consultant

Published April 1, 2002

This paper proposes a simple method for guiding researchers in developing quantitative models of economic fluctuations. We show that a large class of models, including models with various frictions, are equivalent to a prototype growth model with time-varying wedges that, at least at face value, look like time-varying productivity, labor taxes, and capital income taxes. We label the time-varying wedges as efficiency wedges, labor wedges, and investment wedges. We use data to measure these wedges and then feed them back into the prototype growth model. We then assess the fraction of fluctuations accounted for by these wedges during the great depressions of the 1930s in the United States, Germany, and Canada. We find that the efficiency and labor wedges in combination account for essentially all of the declines and subsequent recoveries. Investment wedges play, at best, a minor role.

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