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

  • Lawrence J. Christiano
  • Martin Eichenbaum

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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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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  1. Christiano, Lawrence J, 1987. "Is Consumption Insufficiently Sensitive to Innovations in Income?," American Economic Review, American Economic Association, vol. 77(2), pages 337-41, May.
  2. Fischer, Stanley, 1988. "Recent Developments in Macroeconomics," Economic Journal, Royal Economic Society, vol. 98(391), pages 294-339, June.
  3. Modigliani, Franco, 1977. "The Monetarist Controversy or, Should We Forsake Stabilization Policies?," American Economic Review, American Economic Association, vol. 67(2), pages 1-19, March.
  4. Lucas, Robert E, Jr, 1970. "Capacity, Overtime, and Empirical Production Functions," American Economic Review, American Economic Association, vol. 60(2), pages 23-27, May.
  5. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  6. Kydland, Finn E. & Prescott, Edward C., 1988. "The workweek of capital and its cyclical implications," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 343-360.
  7. Hansen, Gary D. & Sargent, Thomas J., 1988. "Straight time and overtime in equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 281-308.
  8. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  9. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  10. 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.
  11. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  12. Martin S. Eichenbaum & Lars Peter Hansen & Kenneth J. Singleton, 1986. "A Time Series Analysis of Representative Agent Models of Consumption andLeisure Choice Under Uncertainty," NBER Working Papers 1981, National Bureau of Economic Research, Inc.
  13. Bils, Mark J, 1985. "Real Wages over the Business Cycle: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 93(4), pages 666-89, August.
  14. Robert J. Barro, 1980. "Output Effects of Government Purchases," NBER Working Papers 0432, National Bureau of Economic Research, Inc.
  15. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
  16. Rogerson, Richard, 1988. "Indivisible labor, lotteries and equilibrium," Journal of Monetary Economics, Elsevier, vol. 21(1), pages 3-16, January.
  17. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  18. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
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