Working Paper: NBER ID: w21956
Authors: Martin Beraja; Erik Hurst; Juan Ospina
Abstract: Making inferences about aggregate business cycles from regional variation alone is diffcult because of economic channels and shocks that differ between regional and aggregate economies. However, we argue that regional business cycles contain valuable information that can help discipline models of aggregate fluctuations. We begin by documenting a strong relationship across US states between local employment and wage growth during the Great Recession. This relationship is much weaker in US aggregates. Then, we present a methodology that combines such regional and aggregate data in order to estimate a medium-scale New Keynesian DSGE model. We find that aggregate demand shocks were important drivers of aggregate employment during the Great Recession, but the wage stickiness necessary for them to account for the slow employment recovery and the modest fall in aggregate wages is inconsistent with the flexibility of wages we observe across US states. Finally, we show that our methodology yields different conclusions about the causes of aggregate employment and wage dynamics between 2007 and 2014 than either estimating our model with aggregate data alone or performing back-of-the-envelope calculations that directly extrapolate from well-identified regional elasticities.
Keywords: Business Cycles; Regional Economics; New Keynesian DSGE Models; Wage Dynamics; Employment Dynamics
JEL Codes: E24; E31; E32; R12; R23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| aggregate demand shocks (E00) | employment during the recession (J68) |
| aggregate labor supply shocks (J20) | sluggish recovery in employment (F66) |
| regional wage flexibility (J31) | aggregate wage stickiness (C54) |
| using only aggregate data (C80) | overestimation of demand shocks (E39) |
| using only aggregate data (C80) | underestimation of wage flexibility (J31) |
| state-level wage growth (J39) | employment growth (O49) |
| employment growth (O49) | state-level wage growth (J39) |