The Labor Market in Real Business Cycle Theory

Abstract

The basic objective of the real business cycle research program is to use the neoclassical growth model to interpret observed patterns of fluctuations in overall economic activity.If we take a simple version of the model, calibrate it to be consistent with long-run growth facts, and subject it to random technology shocks calibrated to observed Solow residuals, the model displays short-run cyclical behavior that is qualitatively and quantitatively similar to that displayed by actual economies along many important dimensions.For example, the model predicts that consumption will be less than half as volatile as output, that investment will be about three times as volatile as output, and that consumption, investment, and employment will be strongly positively correlated with output, just as in the postwar U.S. time series.1 In this sense, the real business cycle approach can be thought of as providing a benchmark for the study of aggregate fluctuations.In this paper, we analyze the implications of real business cycle theory for the labor market.In particular, we focus on two facts about U.S. time series: the fact that hours worked fluctuate considerably more than productivity and the fact that the correlation between hours worked and productivity is close to zero. 2 These facts and the failure of simple real business cycle models to account for them have received considerable attention in the literature.[See, for example, the extended discussion by Christiano and Eichenbaum (1992) and the references they provide.]Here we first document the facts.

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