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The Great Moderation and Changes in the Structure of Labor Compensation

  • Francesco Nucci
  • Marianna Riggi

A shift in the correlation structure of U.S. macroeconomic series has been documented by Galí and Gambetti (2009) with corresponding changes in the dynamic responses to shocks. We provide an explanation of these findings based on the observed change in the structure of labor compensation and, in particular, on the higher incidence since 1980s of performance-related pay schemes, which has increased the performance sensitivity of compensation. We capture this feature in a DSGE model of the New Keynesian type and show that this interpretation alone can account for the observed changes in the pattern of responses to shocks. In particular, with a higher sensitivity of compensation to workers performance, the response of labor productivity to a non-technology shock switches sign from positive to negative values and the contractionary effect on hours of a technology shock becomes of a smaller size in absolute terms. Alternative explanations of the Great Moderation based on structural changes fall short of accounting for both these documented changes in the dynamic responses to shocks.

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Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 124.

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Length: 44
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:sap:wpaper:wp124
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  1. Efrem Castelnuovo & Paolo Surico, 2006. "The price puzzle: fact or artefact?," Bank of England working papers 288, Bank of England.
  2. Vicente Cuñat & Maria Guadalupe, 2005. "How does product market competition shape incentive contracts?," LSE Research Online Documents on Economics 19894, London School of Economics and Political Science, LSE Library.
  3. Jordi Gali & Pau Rabanal, 2004. "Technology Shocks and Aggregate Fluctuations: How Well Does the RBS Model Fit Postwar U.S. Data?," NBER Working Papers 10636, National Bureau of Economic Research, Inc.
  4. Olivier J. Blanchard & Jordi Gali, 2007. "The Macroeconomic Effects of Oil Shocks: Why are the 2000s So Different from the 1970s?," NBER Working Papers 13368, National Bureau of Economic Research, Inc.
  5. Bils, Mark & Cho, Jang-Ok, 1994. "Cyclical factor utilization," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 319-354, April.
  6. Olivier J. Blanchard & Marianna Riggi, 2013. "WHY ARE THE 2000s SO DIFFERENT FROM THE 1970s? A STRUCTURAL INTERPRETATION OF CHANGES IN THE MACROECONOMIC EFFECTS OF OIL PRICES," Journal of the European Economic Association, European Economic Association, vol. 11(5), pages 1032-1052, October.
  7. Riggi, Marianna & Tancioni, Massimiliano, 2010. "Nominal vs real wage rigidities in New Keynesian models with hiring costs: A Bayesian evaluation," Journal of Economic Dynamics and Control, Elsevier, vol. 34(7), pages 1305-1324, July.
  8. Cuñat, Vicente & Guadalupe, Maria, 2006. "Globalization and the Provision of Incentives Inside the Firm," CEPR Discussion Papers 5950, C.E.P.R. Discussion Papers.
  9. Luca Gambetti & Jordi Gal�, 2009. "On the Sources of the Great Moderation," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 26-57, January.
  10. Alejandro Justiniano & Giorgio E. Primiceri, 2006. "The Time Varying Volatility of Macroeconomic Fluctuations," NBER Working Papers 12022, National Bureau of Economic Research, Inc.
  11. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  12. Benati, Luca & Surico, Paolo, 2008. "VAR analysis and the Great Moderation," Working Paper Series 0866, European Central Bank.
  13. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
  14. Marianna Riggi, 2010. "Nominal And Real Wage Rigidities In New Keynesian Models: A Critical Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 24(3), pages 539-572, 07.
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