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Ramsey-Cass-Koopman Model

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2. Methodological Considerations Theoretical Issues The theoretical underpinning of economic recessions can be traced to the Keynesian perspective where effective demand plays a vital role in output determination. This view underscores the crucial role of fiscal policy tools as a panacea for economic growth. Thereafter, the neoclassical view emerged with a view to synthesizing earlier ideas from the classical perspectives to Keynes. This led to a proliferation of models that tried to analyse the behaviour of the economy in terms of monetarism through the mechanics of investment, interest rate, growth models and large scale macroeconometric models. It was observed that the preceding models did not account for expectations. This is important …show more content…

The key divergence of this school from previous views is that fluctuations are the outcomes of shocks under a perfectly competitive market setting with flexible prices and wages. An important strand from the new classical theorist emerged from the real business cycle models ala Kydland and Prescott (1982), Long and Plosser (1983), and Prescott (1986) among others. The underlying hypothesis is that output is at its natural level which, is subject to contemporaneous distortion from its steady state path. This changes are ascribed to changes in decisions at the micro level (the Ramsey-Cass-Koopman models). The model relaxes the assumption of market imperfection raised by household heterogeneity and intergenerational linkages (Romer, 2006, p. 48). The overlapping-generation model of Diamond (1965) overcomes these limitations by accounting for population …show more content…

179). The employment variation on the other hand works through the household utility which, is a function of consumption and employment. The importance of these parameters in the business cycle theory provide the basis for integrating the model with growth theory in addition to the challenges in distinguishing between long run growth and short run cyclical fluctuations (Kydland and Prescott, 1982). Further, the variables of interest in both models are similar. Although the principle of calibration often used to solve real business cycle models within a general equilibrium framework was not used by Kydland and Prescott (1982), they acknowledge the use of econometric techniques such as the VAR model proposed by Sims

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