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Can market-clearing models explain U.S. labor market fluctuations?

  • Victor E. Li
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    Throughout the past two decades, market-clearing models of the business cycle have been praised for their ability to explain key empirical features of the post-war U.S. business cycle. Real business cycle (RBC) theory shows that in a model grounded in microeconomic foundations, disturbances to national productivity can explain how aggregate variables such as GDP, consumption and investment behave over time, relative to each other. One of the primary weaknesses of the standard RBC model, however, is its inability to account for some important aspects of U.S. labor market fluctuations. In this article, Victor E. Li summarizes important U.S. business cycle facts and examines how and why these market-clearing models have so much difficulty explaining the mannner in which these facts pertain to the labor market. Li then develops a simple market-clearing framework that demonstrates how a more realistic treatment of unemployment and incomplete risk-sharing may provide an alternative approach to better account for these labor market facts. In particular, Li looks at the situation where the risk of being unemployed cannot be completely shared across all individuals when there are unexpected aggregate economic shocks.

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    Article provided by Federal Reserve Bank of St. Louis in its journal Review.

    Volume (Year): (1999)
    Issue (Month): Jul ()
    Pages: 35-49

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    Handle: RePEc:fip:fedlrv:y:1999:i:jul:p:35-49:n:v.81no.4
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    1. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    2. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
    3. Jess Benhabib & Richard Rogerson & Randall Wright, 1991. "Homework in macroeconomics: household production and aggregate fluctuations," Staff Report 135, Federal Reserve Bank of Minneapolis.
    4. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
    5. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Current Real-Business-Cycle Theories and Aggregate Labor-Market Fluctuations," American Economic Review, American Economic Association, vol. 82(3), pages 430-50, June.
    6. Finn E. Kydland, 1993. "Business cycles and aggregate labor-market fluctuations," Working Paper 9312, Federal Reserve Bank of Cleveland.
    7. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
    8. Michael R. Pakko, 1997. "The business cycle and chain-weighted GDP: has our perspective changed?," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 39-49.
    9. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
    10. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
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