In his attack (pdf) upon macroeconomic theory, Paul Romer is especially critical of the real business cycle view that recessions are caused by negative technology shocks. He calls them “phlogiston shocks” and says:
there is no microeconomic evidence for the negative phlogiston shocks that the model invokes nor any sensible theoretical interpretation of what a negative phlogiston shock would mean.
Simon accuses him of attacking a straw man, saying that “the insistence on productivity shocks as business cycle drivers is pretty dated.” And the standard undergraduate textbook, Carlin and Soskice’s Macroeconomics, says RBC theory “is not the mainstream view.”
Looking through a macro prism, such scepticism is reasonable. How can people forget how to do things? Yes, there can be intellectual regress (which is what Romer alleges of DSGE models!) but surely not at the frequency of business cycles.
However, if we ditch representative agent thinking and think instead of firms as being inherently heterogenous, the notion of a negative technology shock seems more reasonable.
Xavier Gabaix points out that even in a large economy aggregate fluctuations can arise from the failure of one or two big firms. This is especially possible if those firms are important hubs, whose troubles plunge supplier or customer firms into trouble: as Daron Acemoglu shows, networks are crucial in transmitting (or dampening) firm-level shocks throughout the economy.
It seems to me that this is a plausible description of the financial crisis. Banks became less able to supply credit than we thought; this was a firm- or industry-level negative technology shock. And because banks were key hubs, this shock was transmitted to the wider economy.
You can squeeze this into DSGE-style models, as (for example) Michael Wickens (pdf) and Hashem Pesaran (pdf) have done. Whether you should do so, though, is another matter: I fear that such exercises might be examples of economists seeing something happening in the real world and wondering if it is possible in theory.
However, evidence on the importance of firm-level shocks is not confined to 2008-09. In Coping with Recession Paul Geroski and Paul Gregg estimate that just 10% of firms accounted for 85% of the drop in employment in the 1989-91 recession. It’s not clear whether this was due to an identifiable single technology shock or what. But this is strong evidence that heterogeneity matters. They wrote:
Describing what happens during recessions using simple macroeconomic aggregates and representative firm models of the economy produces a seriously distorted picture of events. Recessions are about what happens to differences between firms much more than they are about what happens to firms on average.
Now, I’m not saying here that recessions are always and everywhere technological phenomena; recessions differ and maybe there’s no single general theory of what causes them. Nor does this view necessarily have policy implications. One could argue that whatever causes recessions, the response should be expansionary macro policy.
There might, however, be one implication of this. If recessions are occasionally due to technology shocks, then they might be sometimes be inevitable and unpreventable by macro policy: the consistent failure of economists to forecast recessions is consistent with this (though not proof of it).
What I’m doing here is making a plea. In throwing out the bathwater of representative agents and the very dirty bathwater of equilibrium business cycles, economists should be careful to keep the baby of possible technology shocks.