Overcoming the Barro-King Curse in New Keynesian Business Cycle Models

The question of what causes business cycle fluctuations across economies has left scholars on a continuous debate over time. Considering the objective to understand the major factors behind such fluctuations and seeking for an empirical evidence to suggest the necessary requirements of economies to deal with fluctuations, various business cycle models have been developed. The traditional macroeconomic models were challenged by Lucas Critics (1976) for their weakness to fully predict effects of policies based on historically observed relationships. Kydland and Prescot's (1982) response to the critics contributed for the birth of a DSGE real business cycle model based on forward-looking, stochastic, micro-founded and structural contexts where technology or total factor productivity is presumed to be the source of fluctuations in economies. Total factor productivity shocks have been at the center stage to explain economic fluctuations and attempts to consider other potential shocks have been limited as it was also strengthened by the Barro-King Curse's (1984) theoretical prediction which states that shocks other than those to total factor productivity (TFP) will have difficulty in generating business cycle co-movements. Recently, the contributions by Khan and Tsoukalas (2010), Jestiniano et al. (2010) and Ascari et al. (2016) are focusing on investment specific shocks. Cognizant with these understanding, this study attempted to overcome the Barro-King Curse (1984) associated with the New Keynesian Business Cycle modelsby adding existence of per capita income growth, networking among firms and financial intermediaries. Accordingly, marginal efficiency of investment shock is found to be more relevant than neutral technology shocks and the curse can be removed automatically.