To Invalidate Real Business Cycle (RBC) Theory, We Must Refute the Fundamental Causal Factors that RBC Theory Claims to be at Work

I show that RBC (Real Business Cycle) theory, in all of its variations, is not a valid theory of the business cycle. Hence, it does not provide a valid explanation of recessions and depressions. This is the case primarily because it does not explain the type of economy-wide fluctuations we see and the events that occur on the side of money during the business cycle. These observations, in essence, were made long ago by the great Austrian economist Ludwig von Mises in his comments on nonmonetary explanations of the business cycle. He showed that they are all invalid. My analysis goes much farther than Mises's analysis because I go into much more detail to show why RBC theory is invalid. I also cover a far broader range of topics than Mises. However, his analysis does serve as a guide for my analysis.

In considering my critique of RBC theory, one should keep in mind that there are many RBC theories. The critiques I provide below can be used to refute all of them. This is the case because all the different RBC theories are fundamentally the same; they are all based on some nonmonetary explanation of the business cycle. Hence, in order to refute RBC theory, one does not have to refute every specific RBC theory. One can generalize from the specific versions of RBC theory addressed below to refute other versions not mentioned here. Hence I focus on the more prominent RBC theories.

The most important task in showing that RBC theory is invalid is to refute the fundamental causal factors that RBC theory claims to be at work. Once the fundamental claims are shown to be invalid, no version of it will be tenable. As an analogy, think of it this way: once the foundation of a skyscraper is shown to be weak, one does not have to show that the structure of a particular floor of the building is weak to be sure that the floor is in danger of collapsing. That floor, and every other floor, will collapse because of the weak foundation. The same is true of different RBC theories.

--Brian P. Simpson, Remedies and Alternative Theories, vol. 2 of Money, Banking, and the Business Cycle (New York: Palgrave Macmillan, 2014), 80-81.