Ebook How Important is the Intermediate Input Channel in Explaining Sectoral Employment Comovement over the Business Cycle?
It is well known that, over the business cycle, most sectors of the economy move up and down together. This comovement is a central part of the definition of the business cycle. Under the National Bureau of Economic Research's (NBER) definition, for example, "a recession is a period of decline in total output, income, employment, and trade, usually lasting from six months to a year, and marked by widespread contractions in many sectors of the economy." More recently, Christiano and Fitzgerald (1998) document substantial business cycle comovement for hours worked across sectors in the US.
Over the last two decades, however, macroeconomists have mainly focused on understanding the persistence and volatility in the cyclical fluctuations of aggregate economic data. Standard models of business cycles such as Kydland and Prescott (1982) and King et al. (1988), consider a single sector economy to examine the ups and downs of aggregate economic activity. For the obvious reason, these models are not useful to explain a key defining characteristic of the business cycle: the comovement of economic activity across many sectors.
Motivated by the observation that some of the output of the nondurable goods sector is also used as intermediate goods in the production of durable (investment) goods, Hornstein and Praschnik (1997) modify a standard real business cycle model to accommodate this "intermediate goods channel" of the economy. During a boom, this has the effect of increasing the value of output in the nondurable (or consumption) sector with the increased need for its output for use in the investment sector. With indivisible labor and perfectly mobile labor across the two sectors, their model generates strong contemporaneous correlation for sectoral employment.
However, the Hornstein-Praschnik's two sector model is not consistent with the observed comovement in investment across sectors. Christiano and Fitzgerald (1998) also examine data on the subsectors of the nondurable goods sector and note the "weak" relationship between employment comovement and the intermediate goods channel, measured as the fraction of a nondurable sector's gross output which is used as intermediate goods sent for the production of final investment goods. In order to further explore the role of the intermediate goods channel in accounting for comovement of employment and investment across sectors, we consider a much broader intermediate goods channel which allows for the potential uses of a sector's output (nondurable or durable) as intermediate inputs and/or capital inputs in the production of nondurables or durables (including final investment goods).
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