Working Paper: NBER ID: w12079
Authors: Andres Arias; Gary D. Hansen; Lee E. Ohanian
Abstract: This paper shows that a standard Real Business Cycle model driven by productivity shocks can successfully account for the 50 percent decline in cyclical volatility of output and its components, and labor input that has occurred since 1983. The model is successful because the volatility of productivity shocks has also declined significantly over the same time period. We then investigate whether the decline in the volatility of the Solow Residual is due to changes in the volatility of some other shock operating through a channel that is absent in the standard model. We therefore develop a model with variable capacity and labor utilization. We investigate whether government spending shocks, shocks that affect the household's first order condition for labor, and shocks that affect the household's first order condition for saving can plausibly account for the change in TFP volatility and in the volatility of output, its components, and labor. We find that none of these shocks are able to do this. This suggests that successfully accounting for the post-1983 decline in business cycle volatility requires a change in the volatility of a productivity-like shock operating within a standard growth model.
Keywords: Business Cycle; Volatility; Productivity Shocks
JEL Codes: E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Volatility of productivity shocks (O49) | Cyclical volatility of output (E32) |
| Volatility of productivity shocks (O49) | Cyclical volatility of labor input (J22) |
| Decline in productivity shock volatility (E39) | Decline in business cycle volatility (E32) |
| Other shocks (government spending shocks, preference shocks) (E19) | Changes in TFP volatility (O49) |