Working Paper: NBER ID: w2700
Authors: Lawrence J. Christiano; Martin Eichenbaum
Abstract: 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.
Keywords: Real Business Cycle; Labor Market; Government Spending; Technology Shocks
JEL Codes: E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government spending shocks (E62) | Labor supply curve shifts (J29) |
| Government spending shocks (E62) | Labor market dynamics (J29) |
| Labor supply curve shifts (J29) | Correlation between real wages and hours worked (J38) |
| Government spending shocks (E62) | Negative correlation between hours worked and real wages (J31) |
| Existing RBC models (C59) | Overstate expected correlation based on technology shocks (C51) |