Ebook Labor-Supply Shifts and Economic Fluctuations
A leading question in macroeconomics is the identification of forces that cause the cyclical allocation of time. Modern dynamic stochastic general equilibrium analysis emphasizes random shifts in labor demand due to technological progress. Empirical studies on the decomposition of working hours, e.g., Shapiro and Watson (1988) and Hall (1997), have called for an attention to labor-supply movements. For example, Hall (1997) finds a predominant role of labor-supply shifts for fluctuations in hours worked. He suggests non-market activities such as job-search or home production as possible causes for labor-supply shifts.
This paper examines the importance of labor-supply shifts as a source of economic fluctuations. First, we develop and apply a new identification procedure for vector autoregressions (VAR) to decompose the fluctuation of aggregate hours and output into movements along the short-run labor demand schedule and shifts of the demand curve itself. The former is interpreted broadly as response to a labor supply shock. Our identifying restrictions are based on the notion that in reaction to a temporary labor supply shock hours will rise and labor productivity will fall, as the production capacity is fixed in the short-run and the economy operates along the decreasing marginal product-of-labor schedule. Second, we impose additional restrictions by estimating a fully-specified dynamic stochastic general equilibrium (DSGE) model. The DSGE model potentially yields a more precise estimate of the relative importance of labor supply shifts. We consider a model in which labor supply shifts are caused by changes in home production activities. This model was developed by Benhabib, Rogerson, and Wright (1991) and Greenwood and Hercowitz (1991).
The main empirical findings can be summarized as follows. According to the VAR variance decomposition, labor-supply shocks play an important role as a source of fluctuations of hours. Temporary shifts in labor supply account for about half of the cyclical variation of working hours. This finding is consistent with the results reported in Shapiro and Watson (1988) and Hall (1997). Labor supply shocks are less important for output fluctuations as they explain not more than 15 percent of the variation in output.
The DSGE model analysis yields similar results. While more than 50 percent of the variation of hours is attributed to temporary labor supply shifts, only 13 percent of the output fluctuations are due to labor supply movements.
The DSGE model also provides estimates of the evolution of market and home technology over time. The latter measures the attractiveness of non-market activities. According to the home production model, recessions may occur because agents find it optimal to spend more time in non-market activities. While there are alternative explanations for recessions that are not captured by the simple DSGE model, we find it interesting to compare the estimates of the latent technologies to the NBER business cycle dates. Taken at face value, two out of six business cycle troughs during the period from 1960:I to 1997:IV, namely March 1975 and November 1982, coincide with unusually high productivity of non-market activity.
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