Last week,  Dana Galizia presented his job market paper to the department. Once again, this paper is quite different from the two previous job market presentations I have discussed. Galizia is a macroeconomist, working on the big picture issue of business cycles.

Macroeconomics is possibly the most visible branch of economics, but it is also probably the most misunderstood by non-economists. Macroeconomics really takes the motto “all models are wrong, but some models are useful” to heart. A macroeconomist will build a highly stylised model that attempts to explain a particular issue in the economy (trying to explain everything at once is just too difficult!).

It is often thought that productivity shocks play a large part in driving business cycles. Productivity shocks can be thought of as things like weather shocks (drought, floods etc.) or international developments (revolutions and wars, for example) that affect global prices and resource supplies. The problem is that when you try to build a model where business cycles are driven by productivity shocks it normally requires productivity shocks that are unrealistically large (by a factor of 5 or more) to get the models to work.

Why is this? Well, the basic macroeconomic models are built around a steady state, which means that in the absence of any shocks the model produces  a constant rate of growth. So to generate business cycles we need a lot of shocks to push the model away from the steady state.

Galizia takes a different approach. He builds on underlying model that already has some cycles built in (these are called limit cycles). In the absence of any shocks, Galizia’s model will exhibit perfectly regular business cycles, which are generated by changes in the amount of purchases made in response to unemployment risks.

Obviously the real economy does not exhibit perfectly regular business cycles, so Galizia adds in some productivity shocks. Because Galizia’s model already has cycles built in, the productivity shocks that are required to generate realistic business cycles are of a much more realistic size (in fact, the productivity shocks in Galizia’s model are actually slightly smaller than those observed in real world data).

Galizia’s model would not be very useful for predicting future economic trends (that is not what it was built for), but it does demonstrate that we can build a model of business cycles with realistic productivity shocks. This is a foundational work, which introduces some key techniques which can now be applied to other, more realistic models.