80 AEA PAPERS AND PROCEEDINGS MAY/984 generate results that look Keynesian. Simi- The other main objection to real business larly, the Keynesian model still has its dif- cycle theory is that it fails to address the link ficulties with inflation and supply shocks between money and real variables. At least difficulties that were the prime reasons for through the 1930s, the main positive associa the widespread and growing dissatisfaction tion between monetary aggregates and real with this model since the late 1960s variables derives from fluctuations in the If we look beyond the issue of monetary quantity of financial intermediation-that is nonneutrality, then we do find areas of mac- the volume of deposits and loans-rathe roeconomics that use rational expectations than from shifts in the monetary base and in which important recent progress has In many cases, the economic contractions been made. One area concerns real theories were accompanied by banking panics, which of business fluctuations-that is, fluctuations tended to feature the suspension of convert in real economic activity that reflect underly- ibility between deposits and currency press skepticism that aggregate real shocks difficult to see why a sudden decline in the occur with sufficient size and frequency to quantity of financial intermediation would account for a major part of the business have adverse real consequences for the econ cycle. For exampl le, after mentioning the oil omy. In fact, a cutback in financial inter crises and harvest failures, one is often asked mediation is not so different from a negative to name the third example of an important shock to production functions, which is the real shock. In this regard, I find David type of disturbance that appears in real theo- Lilien's research(1982)to be particularly ries of business cycles. Thus, the main chal promising. He shows that greater dispersion lenge is to explain why the earlier financial in the shifts to technology and tastes-with system was subject to occasional crises-not no necessary aggregate bias-can lead to why these crises, once they occurred, would significant and persistent effects on the ag- have serious repercussions on output and gregates of output and employment. In employment. It seems likely that deposit in assessing the empirical significance of this surance plays an important role in this story approach, we could look at the major changes Even in the post-World War II period in patterns of international comparative ad there is evidence that much of the interplay vantage that have occurred since the early between money and real activity reflects 1970,s. These changes show up, for example, fluctuations in deposits and in credit aggre as a faster rate of decline in the share of U.S. gates, rather than the monetary base. Thus output that is accounted for by the manufac- money may serve more as an indicator of turing sector. We would look also at the changes in business conditions, rather than volatility in the relative prices of internation- as a major exogenous influence on real vari ally traded goods, which are not limited to ables. However, evidence on the interactions elative prices seem between the monetary base and real vari- to have a great deal to do with the gyrations ables still suggests some amount of monetary in real exchange rates over the last decade. nonneutrality, which we would like to ex- Overall, it seems that real theories are espe- plain. In fact, this type of interplay between cially promising for explaining the sharp monetary and real variables during relatively fluctuations in real economic activity and the minor recessions may be quantitatively in tendency for increases in unemployment rates line with the rational expectations models since the early1970’s which stress the role of incomplete informa tion about money and prices. Thus, we may be able to resolve the puzzle of moneta nonneutrality by arguing first, that much of 2One of the more remarkable recent developments is the empirical association between money and the view that long-term contracts can rescue the old real variables is not evidence of nonneutral activism. It is hard to see how the ability to contract could lessen the private econo ity, and second, that the existing theories can ability to deal with disturbances and thereby enhance account for the relatively small amount of the case for Keynesian macropolicies nonneutrality that remains