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Is Theory Really Ahead of Measurement? Current Real Business Cycle Theories and Aggregate Labor Market Fluctuations

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  • Lawrence J. Christiano
  • Martin Eichenbaum

Abstract

In the l93Os, Dunlop and Tarshis observed that the correlation between hours and wages is close to zero. This classic observation has become a litmus test by which macroeconomic models are judged. Existing real business cycle models fail this test dramatically. Based on this result, we argue that technology shocks cannot be the sole impulse driving post-war U.S. business cycles. We modify prototypical real business cycle models by allowing government spending shocks to influence labor market dynamics in a way suggested by Aschauer (1985), Barro (1981, 1987) and Kormendi (1983), This modification can, in principle, bring the models into closer conformity with the data. While the empirical performance of the models is significantly improved, they still fail to account for the Dunlop-Tarshis observation. Accounting for that observation will require further advances in model development. Consequently, we conclude that theory is behind, not ahead of, business cycle measurement.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2700.

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Date of creation: Sep 1988
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Publication status: published as American Economic Review Vol. 82, No. 3, pp. 430-450 June 1992
Handle: RePEc:nbr:nberwo:2700

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