Working Paper: CEPR ID: DP5631
Authors: John Fernald
Abstract: Structural vector-autoregressions with long-run restrictions are extraordinarily sensitive to low-frequency correlations. This paper explores this sensitivity analytically and via simulations, focusing on the contentious issue of whether hours worked rise or fall when technology improves. Recent literature finds that when hours per person enter the VAR in levels, hours rise; when they enter in differences, hours fall. However, once we allow for (statistically and economically plausible) trend breaks in productivity, the treatment of hours is relatively unimportant: Hours fall sharply on impact following a technology improvement. The issue is the common high-low-high pattern of hours per capita and productivity growth since World-War II. Such low-frequency correlation almost inevitably implies a positive estimated impulse response. The trend breaks control for this correlation. In addition, the specification with breaks can easily 'explain' (or encompass) the positive estimated response when the breaks are omitted; in contrast, the no-breaks specification has more difficulty explaining the negative response when breaks are included. More generally, this example suggests a need for care in applying the long-run-restrictions approach.
Keywords: business cycles; structural change; technology
JEL Codes: E24; E32; O47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Specification with breaks (Y20) | Explanation of positive estimated response when breaks are omitted (C51) |
| No-breaks specification (Y20) | Struggles to account for negative response when breaks are included (C99) |
| Technology improvements (O39) | Hours worked (J22) |
| Hours worked per capita (levels) (J89) | Hours worked (rise) (J29) |
| Hours worked per capita (differences) (J89) | Hours worked (fall) (J22) |
| Trend breaks in productivity (O49) | Hours worked response after technology improvements (J29) |
| Common high-low-high pattern in productivity growth and hours worked (J29) | Positive impulse response of hours worked to technology shocks (J29) |