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Current real business cycle theories and aggregate labor market fluctuations

  • Lawrence J. Christiano
  • Martin Eichenbaum

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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Paper provided by Federal Reserve Bank of Minneapolis in its series Discussion Paper / Institute for Empirical Macroeconomics with number 24.

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Date of creation: 1990
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Handle: RePEc:fip:fedmem:24
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  1. Robert J. Barro & Robert G. King, 1982. "Time-Separable Preference and Intertemporal-Substitution Models of Business Cycles," NBER Working Papers 0888, National Bureau of Economic Research, Inc.
  2. David Aschauer, 1988. "Does public capital crowd out private capital?," Staff Memoranda 88-10, Federal Reserve Bank of Chicago.
  3. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  4. Orley Ashenfelter, 1984. "Macroeconomic Analysis and Microeconomic Analyses of Labor Supply," NBER Working Papers 1500, National Bureau of Economic Research, Inc.
  5. 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.
  6. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  7. Barro, Robert J, 1981. "Output Effects of Government Purchases," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1086-1121, December.
  8. Gilbert Ghez & Gary S. Becker, 1975. "The Allocation of Time and Goods over the Life Cycle," NBER Books, National Bureau of Economic Research, Inc, number ghez75-1, June.
  9. 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.
  10. Aschauer, David Alan, 1985. "Fiscal Policy and Aggregate Demand," American Economic Review, American Economic Association, vol. 75(1), pages 117-27, March.
  11. Bencivenga, Valerie R, 1992. "An Econometric Study of Hours and Output Variation with Preference Shocks," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 33(2), pages 449-71, May.
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