Excerpt from Is the Business Cycle a Necessary Consequence of Stochastic Growth?

An even more important novelty in our analysis is that we identify three features of the co - movement of various forecasted series that are inconsistent with our basic stochastic growth model. The first is that predictable movements in output and predictable movements in the average product of labor bear little relation to each other and, when they are related to each other, they are often negatively correlated. By contrast, the model associates predictable increases in output with capital accumulation which raises labor productivity. Thus predictable movements in output should be strongly positively associated with predictable movements in productivity. The second is that predictable increases in output are correlated with predictable increases in the labor input. By contrast, under standard calibrations, the growth model implies that the labor input should be above its long run value when output is below its long run value, and vice versa, so that the two quantities are always expected to move in opposite directions. Finally, as has been pointed out repeatedly (see e.g., Campbell 1987, Cochrane 1994a), the data suggest that high levels of the ratio of consumption to output are associated with increases in output (and with smaller increases in consumption). We show that this too is inconsistent with the growth model.

We thus believe that we have identified important respects in which a simple stochastic growth model does not predict aggregate fluctuations of the kind observed. It might be argued that this is a fine point.

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