Current real business cycle theories and aggregate labor market fluctuations
In the 1930s, Dunlop and Tarshis observed that the correlation between hours worked and the return to working is close to zero. This 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 consumption shocks to influence labor market dynamics in a way suggested by Aschauer (1985), Baro (1981, 1987), and Kormendi (1983). This modification can, in principle, bring the models into closer conformity with the data. Our results indicate that when aggregate demand shocks arising from stochastic movements in government consumption are incorporated into the analysis, and an empirically plausible degree of measurement error is allowed for, the model’s empirical performance is substantially improved.
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"Indivisible labor and the business cycle,"
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- Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
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- Robert J. Barro & Robert G. King, 1984. "Time-Separable Preferences and Intertemporal-Substitution Models of Business Cycles," The Quarterly Journal of Economics, Oxford University Press, vol. 99(4), pages 817-839.
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- Finn Kydland & Edward C. Prescott, 1980. "A Competitive Theory of Fluctuations and the Feasibility and Desirability of Stabilization Policy," NBER Chapters,in: Rational Expectations and Economic Policy, pages 169-198 National Bureau of Economic Research, Inc.
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- Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February. Full references (including those not matched with items on IDEAS)
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