edsjsr.116987

Technology, Employment, and the Business Cycle: DoTechnology Shocks Explain Aggregate Fluctuations?

JORD! GALi*

/ estimate a decomposition of productivity and hours into technology and non-technology components. Two results .stand out: (a) the estimated conditionalcorrelations of hours and productivity are negative for technology shocks, pos-itive for nontechnology shocks; (b) hours show a persistent decline in responseto a positive technology shock. Most of the results hold for a variety of modelspecifications, and for the majority of G7 countries. The picture that emerges ishard to reconcile with a conventional real-business-cycle interpretation of busi-ness cycles, but is shown to be consistent with a simple model with monopolisticcompetition and sticky prices. (JEL E32, E24)

Real-business-cycle (RBC) theory, exem-plified by the work of Finn E. Kydland andEdward C. Prescott (1982) and its subsequentextensions, interprets the bulk of aggregatefluctuations observed in the postwar U.S.economy as being consistent with the compet-itive equilibrium of a neoclassical growthmodel augmented with a labor-leisure choiceand exogenous technology shocks. In additionto its theoretical appeal, proponents of theRBC paradigm point to its successful empiri-cal performance as a reason for taking seri-ously its account of the mechanisms throughwhich shocks impact the economy and arepropagated over time.

* Departmeiil of Economics, New York Universily,269 Mercer Sireet. New York, NY 10003 (e-mail:[email protected]). The paper has benefited fromcomments by Daron Acemoglu, Susanto Basu. OlivierBlanchard. Bill Brainard. Larry Chrisliano. MartinEichenbaum. Mark Gertler, Lutz Kilian. Franck Portier,Xavier Sala-i-Martin. Julio Rotemberg, Chris Sims, KenWest, Mike Woodford, and seminar participants at theNew York Fed, NYU. Yale University. Columbia Uni-versity, Princeton University. MIT. the University ofRochester, the New School. Centro de Estudios Moneta-rios y Financieros (CEMFI). the University of Quebec-Montreal. Ohio State University, the National Bureau ofEconomic Research Summer Institute, the Economic Fluc-tuations and Growth (EFG) Meeting, and the Centre forEconomic Policy Research Summer Symposium (ES-S!M). Tommaso Monacelli provided excellent researchassislance. I thank Universitat Pompeu Fabra for its hos-pitalily. Financial support from the C.V, Starr Center forApplied Economics is gratefully acknowledged.

The present paper questions the usefulnessof the type of evidence generally provided insupport of RBC models, and which focuses ontheir apparent ability to match the pattems ofunconditional second moments of key mac-roeconomic time series.' The main argumentcan be summarized as follows: in order tomatch some key second moments of the dataRBC economists must allow for multiplesources of fluctuations; with the latter, how-ever, the model yields predictions that arestronger than restrictions on the sign and/orpattem of unconditional second moments. Inparticular, it yields predictions in temis of con-ditional second moments, i.e., second mo-ments conditional on a given source offluctuations. In that context, an evaluation cri-terion based on the model's ability to matchunconditional moments may be highly mis-leading: the model can do well according tothat criterion and yet provide a highly distortedpicture of the economy's response to each typeof shock.

That general point is illustrated below in thecontext of a well-known anomaly associated

' See Kydland and Prescott (1996) for a description ofthe approach to model evaluation found in much of theRBC literature, and Christopher A. Sims (1989. 1996) fora critical appraisal of ihal approach. Examples of attemptsto evaluate RBC models by focusing on other dimensionsof their predictions include Mark W. Watson (1993). Gall(1994), and Julio J. Rotemberg and Michael Woodford(1996).

249

250 THE AMERICAN ECONOMIC REVIEW MARCH 1999

with the basic RBC model, namely, its pre-diction of a high positive correlation be-tween hours and labor productivity.^ Thesource of that correlation lies at the root ofthe mechanism underlying macro fluctua-tions in that model: it reflects the shifts in thelabor demand schedule caused by technol-ogy shocks {and, to a less extent, the inducedcapital accumulation), combined with anupward-sloping labor supply. As is wellknown, the above prediction stands in starkcontrast with the near-zero (and often neg-ative) correlation found in the data.^ Thatobservation led researchers to augment themode! with nontechnology shocks, i.e., withshocks that act predominantly as labor-supply shifters, inducing a negative comove-ment between productivity and hours whichcould offset the positive correlation resultingfrom technology shocks. Examples of suchadditional driving forces found in the liter-ature include shocks to government pur-chases (e.g., Lawrence J. Christiano andMartin Eichenbaum, 1992), and preferenceshocks (Valerie Bencivenga, 1992), amongothers. The resulting "augmented" modelscould in principle account for the near-zerocorrelation between hours and productivitywithout departing from the RBC paradigmand, in particular, without altering themodel's predictions regarding the dynamiceffects of technology shocks.

Altemative explanations to the productivity-hours anomaly that depart from the basic RBCparadigm in a more fundamental way do, how-ever, exist. In Section I below I show how astylized model with monopolistic competition,sticky prices, and variable effort can potentiallyexplain the near-zero unconditional correlationbetween productivity and hours while reversingits sources: under plausible assumptions, themodel predicts that technology shocks generatea negative comovement between those two vari-ables, offset by the positive comovement arising

' Henceforth I often use the shorter term productivityto refer to average labor productivity.

' See, e.g., Gary D. Hansen and Randall Wright (1992)for a discussion of the employment-productivity puzzle,as well as other anomalies regarding the labor market pre-dictions of RBC models.

from nontechnology shocks (monetary shocks,in the example economy).

An empirical evaluation of the two classesof models can exploit their different implica-tions regarding the responses of hours and pro-ductivity to each type of shock and, as a result,their conditional correlations. With that goalin mind, I attempt to identify and estimate thecomponents of productivity and labor-inputvariations associated with technology shockson the one hand, and nontechnology shocks onthe other. That decomposition is carried outusing a structural vector autoregressive(VAR) model, identified by means of a long-run restriction which is satisfied by a broadrange of models, including RBC models and"new Keynesian" models (as exemplified bythe model in Section I). Section II contains adescription of the empirical methodology, andof its connection with theoretical models of thebusiness cycle.

Section III presents the results. The base-line evidence reported, based on postwarU.S. data, includes estimates of conditionalcorrelations, as well as estimated impulse re-sponses of output, hours, and productivity totechnology and demand shocks. Several re-sults stand out: (a) the estimated conditionalcorrelations of hours and productivity arenegative for technology shocks, positive fordemand shocks; (b) the impulse responsesshow a persistent decline of hours in re-sponse to a positive technology shock; (c)measured productivity increases temporarilyin response to apositive demand shock; (d)movements in output and hours attributed todemand shocks are strongly positively cor-related, and account for the bulk of postwarbusiness cycles; and (e) neither is true forthe fluctuations attributed to technologyshocks. Overall, the evidence seems to beclearly at odds with the predictions of stan-dard RBC models, but largely consistentwith the class of new Keynesian models ex-emplified by the framework in Section I.Those results, and many others, are shownto be robust to the labor-input measure used(hours or employment), and to the specifi-cation of the underlying structural VAR.Section III also reports related evidencebased on data for the remaining G7 coun-tries. Qualitatively, that evidence largely

VOL. 89 NO. I GAU: TECHNOLOGY, EMPLOYMENT. AND THE BUSINESS CYCLE 251

mirrors the one obtained for the UnitedStates, with the main results holding forevery G7 country but Japan.

In Section IV, I examine the implications ofthe estimated decomposition regarding the roleplayed by technology shocks as sources ofpostwar business cycles. Section V explorespossible ways of reconciling that evidencewith the RBC paradigm. Finally, Section VIsummarizes the main results of the paper andconcludes.

I. Labor-Market Dynamics in a StickyPrice Model

In this section I develop and analyzea monetary model with monopolistic com-petition, sticky prices and variable labor ef-fort.'' I assume two exogenous drivingforces: technology and monetary shocks.The focus of the analysis is on the joint re-sponse of productivity and hours to eachof those disturbances. The model is deli-berately stylized, in order to convey the ba-sic point in the simplest possible way (inother words, it is not meant to provide acomplete account of the mechanisms under-lying business cycles). Thus, capital accu-mulation is ignored, and nominal pricerigidities are introduced by having firmsset their prices before shocks are realized.The assumptions on functional forms andstatistical properties of the shocks make itpossible to derive an exact closed-form rep-resentation of the equilibrium processes forthe variables of interest in terms of the ex-ogenous driving forces.

* Recent examples of dynamic general equilibriummodels of the business cycle with nominal rigidities in-clude Jean-Olivier Hairault and Eranck Portier (1993),Jean-Pascal Benassy (1995), Jang-Ok Cho and ThomasCooley (1995), Jinill Kim (1996), Robert G. King andAlexander L. Wolman (1996), and Rotemberg (1996).Examples of business-cycle models with variable effortand/or utilization can be found in Craig Bumside et al.(l993)andMarkBilsandCho(1994).Robert J.Gordon(1990). Argia M. Sbordone (1995). Susanto Basu(1996), and Matthew D. Shapiro ( 1996), among others,discuss the implications of that phenomenon for the cy-clical behavior of productivity measures.

A. Households

The representative household seeks tomaximize

(1)

M,<, I 0-{ log C + \ . log y - H(N,, V,)

subject to the budget constraint

/ :P,,Cu di + M,

T,

for / = 0, 1, 2,.... C, is a composite consump-tion index defined by

« :

EIE- 1

where C,, is the quantity of good / G [0, 1]consumed in period /, and e > 1 is the elas-ticity of substitution among consumptiongoods. The price of good / is given by P,,, and

=(/,

is the aggregate price index. M denotes (nom-inal) money holdings. Function H measuresthe disutility from work, which depends onhours (A') and effort (U). The following func-tional form is assumed

! \ —,) - "1 +

-I- "I +

U,

T and FI denote, respectively, monetarytransfers and profits. VV and V denote the(nominal) prices of an hour of work and a unitof effort, respectively. /? S (0, 1) is the dis-count factor. \m, X,,, \u, CT^, Uu, are positiveconstants.

The first-order conditions associated withthe household problem are

(2) c . . ^

252 TME AMERICAN ECONOMIC REVIEW MARCH 1999

C, '\ r p

(4)

(5)

w,p,

P,

B. Eirms

There is a continuum of firms distributeduniformly on the unit interval. Each firm isindexed by ( G [0, 1], and produces a differ-entiated good with a technology

Y = 7 I"

L, may be interpreted as the quantity of ef-fective labor input used by the firm, which isa function of hours and effort:

L.,, — 1^ It'-' It

where ^ € (0, 1 ) / Z is an aggregate technol-ogy index, whose growth rate is assumed tofollow an independently and identically dis-tributed (i.i.d.) process {77,}, with TJ, ~ A'(0,sj). Formally,

Z, -

At the end of period / — 1 (i.e., before pe-riod ?'s realization of the money supply andtechnology is observed) firm i sets the priceP,, at which it will be selling good / duringperiod t, taking as given the aggregate pricelevel P,. Once the shocks are realized, eachfirm chooses A' , and (/,, optimally, given W,and V,. Given an output level K,,, cost mini-mization requires

(6)

Furthermore, as long as the marginal cost isbelow the (predetermined) price P,,, each firmwill find it optimal to accommodate anychanges in the demand for its product, and willthus choose an output level

(7) Y ='it

Hence, when setting the price the firm willseek to maximize

max £,_ , i (\/C.)(P,,Y, - W,N,, - V,U,,) }p.,

subject to (6) and (7). The correspondingfirst-order condition is given by

(8) £,_ , { (\/C,)(aOP,,Y, - iiW,N,,) } = 0

where ^ = ele — I /

C. Monetary Policy

The quantity of money W in the economyis assumed to evolve according to

(9) 777,)

where { ,} is a white noise process orthogonalto {77,1 at all leads and lags, with ^, — A^(0,s'^„). Notice that whenever y =/= 0, the monetaryauthority is assumed to respond in a systematicfashion to technology shocks.

D. Equilibrium

In a symmetric equilibrium all firms will setthe same price P, and choose identical output,hours, and effort levels Y,,N,, U,. Goods mar-ket clearing requires C, = C,, = Y^, = Y,, forall I e [0, 1], and all t. Equilibrium in themoney market implies M,/M,., = exp(^, +777,), for all /. Using both market-clearing con-ditions, one can rewrite (3) (after some alge-braic manipulation) as

V,

' Notice that we can write i,,, = N.,((JJN.,)'~", whichimplies that effective labor input is proportional to hours(as in the standard model) whenever effort per hour isconstant.

* Notice that in the absence of uncertainty (8) simpli-fies to P,, = ii(W,N,,/a:OY,,). which is just the familiar op-timal price condition for a monopolist facing an isoetasticdemand schedule.

VOL. 89 NO. I : TECHNOLOGY, EMPLOYMENT. AND THE BUSINESS CYCLE 2S3

(10) C = ^-^' I

where ^ = \,;,'[1 - 0 exp{ 'A(.?, , + 7^-v:)}l.^Furthermore, (4), (5), and (6) imply (J, =^ 1 / ^ . ( 1 " 1 ^ ( 1 + n ^ i / ( i + a , , } ^ w h e r e . 4 = [ X , , ( I —

0)/KB]"'^ """ '""'. That result allows us towrite the following reduced-form equilibrium re-lationship between output and employment:

( I i ) Y, = AZ,Nr

where ^ ^ a^ + rt( 1 - ^)( 1 + (T,,)I(\ + a,,).Finally, evaluating (4) and (8) at the sym-

metric equilibrium and combining themwith (11) and ( 10) one can derive a set ofexpressions for the equilibrium levelsof prices, output, employment, and pro-ductivity, in terms of the exogenous driv-ing variables. Letting lower-case letters de-note the natural logarithm of each variable,and dropping uninteresting constants, wehave:

(12)

(13) Ay, =

(14)

(1 -

1 I - 7

15) A.V, = 1 1 - -

+ I - + y]r),

+ ( 1 - 7 ) 1 1 - - l ^ / - i

where .x = _v - n is the log of (measured) laborproductivity.

'We assume/3 exp { ' / ;( .vi-I-y'j:)} < l.Theconslanlvelocity associated with (10) is a consequence of our as-sumplion of i.i.d money growlh rates, which in tum im-plies a constani nominal rate.

The equilibrium responses of/>, y, n, and^cto each shock, represented by (12) - (15), arediscussed next. A monetary shock has a tran-sitory impact on output, employment, and pro-ductivity, and a jKrmanent effect on the pricelevel. More specifically, and in response to anunanticipated monetary expansion (f, > 0) ,output and employment go up. reverting backto their original level after one period. Thesign of the (also transitory) response of laborproductivity x depends on the size of ip, and ispositive whenever <p > 1. As made clear hy(11), the latter condition corresponds to thenotion of "short-run increasing returns to la-bor" emphasized in the literature on the cy-clical behavior of productivity (e.g.. Gordon.1990). For that condition to be satisfied werequire: (a) sufficiently "productive" effort(low B), (b) a sufficiently low elasticity ofeffort's marginal disutility relative to that ofemployment (o,,'^ a^), and (c) a sufficientlyhigh elasticity of output with respect to effec-tive labor input (high a). Finally, note that theonly variable that is permanently affected bythe exogenous increase in the money supplywill be the price level, which will adjust pro-portionally (though with a one-period lag).

A (positive) technology shock (77, > 0) hasa permanent, one-for-one effect on output andproductivity, as can be seen in (13) and (15).Tbe same shock will have a permanent nega-tive effect on the price level as long as 7 < 1,i.e., if the degree of monetary accommodationis not too strong. Most interestingly, if thesame condition is satisfied, 2i positive technol-ogy shock will have a negative short-run effecton the level of employment. The intuition forthat result is straightforward. Consider, for thesake of exposition, the 7 = 0 case (exogenousmoney). In that case, the combination of aconstant money supply and predeterminedprices implies that real balances (and, thus, ag-gregate demand) remain unchanged in the pe-riod when the technology shock occurs. Eachfirm will thus meet its demand by producingan unchanged level of output. If the technol-ogy shock is positive, producing the same out-put will require less labor input, and a declinein hours will be observed. Clearly, the sign ofthat short-run response of hours to a technol-ogy shock stands in stark contrast with the pre-dictions of the basic RBC model. Furthermore,

254 THE AMERICAN ECONOMIC REVIEW MARCH 1999

unchanged output and lower hours will lead toan unambiguous increase in measured laborproductivity in response to the same shock. Inthe following period, firms adjust their pricesdownward (since marginal cost is lower), ag-gregate demand and output will go up, and em-ployment returns to its original level. The signof the associated change in labor productivitydepends again on whether i is greater or lessthan one (i.e., on whether the change in outputis more or less than proportional to the changein hours), which, in tum, determines whetherthe immediate response of productivity to atechnology shock overshoots or not its long-run level. By looking at (12) - (15) it shouldbe clear that the qualitative effects of a tech-nology shock described above will remain un-changed so long as 7 e [0, 1), a parameterrange which includes both exogenous mone-tary policy as well as a monetary rule aimedat smoothing price and employment changes.**

It is important to stress that the possibilityof a decline in hours in response to a positivetechnology shock does not hinge on the as-sumptions of predetermined prices or absenceof capital accumulation, both made here forexpository convenience. Thus, Rotemberg(1996) obtains a similar response in a modelwith quadratic costs of price adjustment, andfor sufficiently high values of the parameterindexing the magnitude of those costs. A sim-ilar response is found in King and Wolman(1996) in a similar model with capital accu-mulation and a price-setting structure origi-nally found in Guillermo Calvo (1983) .Finally, King and Watson (1996) also reporta negative contemporaneous correlation be-tween multifactor productivity and hours intheir calibrated sticky price model with capitalaccumulation.

The unconditional covariances among thegrowth rates of output, labor productivity, andemployment implied by the above model areeasily computed using (12 ) - ( 15):

(16) cov(Av,. An,)

2si-\-(\

(17) cov(Ay,, Ax,)

(18)

Whenever 7 G [0, Vj) and/or exogenousmonetary shocks are a sufficiently important(relative to technology), the model predictsthat hours growth should be procyclical—aproperty which is a robust feature of the data.Furthermore, 1/5 > 1 is a sufficient conditionfor measured labor productivity to be procy-clical—another strong feature of the data—independently of the relative importance ofthe two shocks.

The sign of the comovement between hoursand productivity growth—the focus of our at-tention—depends on the size of ^p, the policyparameter 7, and the relative importance ofshocks. It is useful to look first at the sign ofthe conditional covariances. Letting cov( An,,Ax, I z) denote the covariance between A«, andAx, conditional on technology being the onlysource of fluctuations, we have:

cov(A«,, AJC,Is)

( l - 7 ) r , .

" More generally, the choice of the policy rule will onlyhave a permanent effect on prices, but it will affect thesize and/or the dynamic pattem of the responses of output,employment, and productivity. In particular, the monetaryauthority will face a trade-off between employment andprice volatility.

Under the assumptions 7 6 [0, I) and (p e( 1, 2) it is easy to check that cov( A«,,Ax, I z) < 0, i.e., technology shocks generatea negative comovement between hours andproductivity growth. On the other hand, the

VOL 89 NO- I GALi: TECHNOLOGY, EMPLOYMENT. AND THE BUSINESS CYCLE 255

analogous covariance conditional on mone-tary shocks heing the only source of fluctu-ations., denoted by cov(Artf, Ax,\ni), isgiven by

cov(An,, Ax,\ni) =• ^ / I •»

whose sign depends the size of ^p. Ifyj > I, monetary shocks will generate apositive comovement between the samevariables.

The case of most interest—and a plausibleone, in my view—corresponds to yj G (1, 2),and 7 G [0, 1), i.e., it combines some "short-run increasing returns to labor" with a not-too-strong endogenous money response. Inthat case the model's predictions regarding thesigns of the unconditional comovementsamong output, hours, and productivity areconsistent with the evidence, and potentiallyclose to those predicted by standard RBCmodels. Yet the two models have very differ-ent implications regarding the conditionalcomovements between hours and productivitygrowth. In particular, if technology shocks arethe only source of fluctuations, the sticky pricemodel predicts a negative correlation betweenhours and productivity growth, whereas thecorresponding comovement conditioned onthe nontechnology shocks is positive. Such aresulc is in stark contrast with the prediction ofstandard RBC models with multiple shockswhere, for the reasons described in the intro-duction, technology shocks are a source of apositive comovement between hours and pro-ductivity, while nontechnology shocks gener-ate a negative comovement.

Next I propose a simple empirical frameworkthat allows me to estimate the conditional cor-relations in the data, and thus assess the relativemerits of the two classes of models.

II. An Empirical Model

In order to estimate their conditional co-movements, the components of hours andproductivity variations associated with tech-nology and nontechnology shocks must bedisentangled. My approach involves the useof a structural VAR model, identified by therestriction that only technology shocks may

have a permanent effect on the level of pro-ductivity. As argued below, that restrictionis satisfied by a broad range of models, in-cluding RBC models, and models with nom-inal rigidities. The conditional correlationsof hours and productivity variations can thenbe computed using the estimated coefficientsof the structural moving average (MA)representation.

A. Assumptions Underlying theIdentification Strategy

Next I discuss three assumptions which arejointly sufficient to yield the identifying re-striction used, and which implicitly determinethe range of models that the framework belowcan embrace.

ASSUMPTION 1: Output is determined ac-cording to a homogeneous of degreeone., strictly concave., aggregate productionfunction

(19)

where Y is output. K and L denote the ef-fective capital and labor-input servicesemployed (thus allowing for possible unob-servable variations in the utilization rate ofboth inputs), and Z is an exogenous tech-nology parameter following a stochastic pro-cess with a unit root (i.e., some technologyshocks have permanent effects on the levelofZ).

ASSUMPTION 2: The capital-labor ratio(measured in efficiency units) K,IZ,L, followsa stationary stochastic process.

The previous assumption is not hard to jus-tify. Letting r, denote the retum on physicalcapital, profit maximization (combined withAssumption 1 and other standard assump-tions) implies

(20) r,=markup

— depreciation rate.

256 THE AMERICAN ECONOMIC REVIEW MARCH 1999

Thus, under the maintained assumption ofstationarity (or constancy) of the markup andthe depreciation rate, the capital-labor ratiowill be stationary whenever the sequence ofreturns { r,} is stationary.'' The latter propertyis consistent with most dynamic models of thebusiness cycle, which display fluctuationsaround a steady state (or balanced growthpath) that corresponds to that of the Ramsey-Cass-Koopmans model or the Solow-Swanmodel.'" Most importantly, that assumptionalso appears to be consistent with the empiricalcharacterizations of the time-series propertiesof asset returns found in the literature."

ASSUMPTION 3: Effective labor input L, isa homogeneous of degree one function ofhours and effort:

(21) L,=^g(N,,U,)

and effort per hour V,1N, follows a stationarystochastic process.

Homogeneity is required if effective laborinput is to be proportional to hours whenevereffort per hour is constant. Stationarity of U,lN, seems empirically plausible and is certainlyconsistent with existing business-cycle modelswith variable effort (e.g., Burnside et al.[ 1993 ], or the model of Section I).

Combining Assumptions 1-3 one can de-rive the following expressionbor productivity:

L.K "M

or, taking logs,

(22) X = 7 + i

where , ^ log F{K,IZ,L,, 1) ^(1, U,IN,) isstationary under the above assumptions. Equa-tion (22) holds the key to the identification oftechnology shocks, for it implies that only per-manent changes in the stochastic componentof the technology parameter ; can be thesource of the unit root in productivity. Put itdifferently, under the assumptions above, onlytechnology shocks can have a permanent effecton the level of labor productivity, even thoughany other shock impinging on the economycan affect labor productivity temporarilythrough its effects on effort per hour and thecapital-labor ratio.'-

The previous condition provides the keyidentifying restriction in the structural VARmodel estimated here. Notice that such a re-striction allows both types of shocks to havepermanent effects on the levels of hours andoutput, and thus does not "mislabel" as tech-nology any other shock that may have suchpermanent effects.'^ From that viewpoint myidentifying restriction is different from the oneoriginally proposed by Blanchard and DannyQuah (1989), and which restricted demandshocks (in their terminology) not to have per-manent effects on the level of output. Also,notice that in contrast with Shapiro andWatson (1988) I do not restrict technologyshocks not to have permanent effects on hours.Though with a different motivation and objec-tives, the identification strategy adopted here

" Clearly, the same property would hold if we were toallow for adjustment costs or any other departure from(20), as long as the stochastic component of that deviationwas stationary.

'" Alternatively, one could have assumed stationarity ofthe capital-output ratio, as in Shapiro and Watson (1988).Combined with (19), either assumption corresponds to astationary real rate.

'' The evidence on stock returns points to small depar-tures from white noise (see. e.g., Kenneth J, Singleton,1990). The evidence on real interest rates is less strong,but generally tends to reject the presence of a unit root(see, e.g., Frederic S. Mishkin. 1992), and the evidencereported below).

' The investment-specific form of technologicalchange assumed in Jeremy Greenwood et al. (1997) is notnested in the present framework, though it is easy to checkthat the identifying restriction proposed here would alsohold in a version of their model with a unit root in theinvestment-specific technology parameter (i.e.. the rela-tive price of equipment), since Ihe capital-labor ratio (andthus labor productivity) is fully pinned down by the (sta-tionary) interest rate and the value of that technologyparameter.

' ' Examples of such shocks include permanent changesin govemment purchases (Marianne Baxter and King.1993), permanent labor supply shocks (Shapiro andWatson, 1988). or even monetary shocks in an insider-outsider model of the labor market (Olivier J. Blanchardand Lawrence H, Summers. 1986).

VOL. 89 NO. I GALf: TECHNOLOGY. EMPLOYMENT, AND THE BUSINESS CYCLE 257

is closer to that in Edward N. Gamber andFrederick L. Joutz (1993), who restrict labor-supply shocks not to have a permanent effecton real wages, while allowing labor- demand/technology shocks to have such a permanenteffect.

B. Specification and ConditionalCorrelations Estimators

My empirical model interprets the observedvariations in (log) productivity (x,) and (log)hours (n,) as originating in two types of ex-ogenous disturbances—technology and non-technology shocks—which are orthogonal toeach other, and whose impact is propagatedover time through various unspecified mech-anisms. That idea is formalized by assumingthat the vector {Ax,, An,]' can be expressedas a (possibly infinite) distributed lag of bothtypes of disturbances:

(23)Ax,An,

where {e;} and {e;"l denote, respectively,the sequences of technology and non-technology shocks. The orthogonality as-sumption (combined with a standard nor-malization) implies Ee,e't = /. Furthermore,the identifying restriction that the unit rootin productivity originates exclusively intechnology shocks corresponds to C'"( I) =0. In other words, the matrix of long-runmultipliers C( I ) is assumed to be lowertriangular.

The specification in (23) is based on theassumption that both productivity and hoursare integrated of order one, so that first-differencing of both variables is necessarylo achieve stationarity. That assumption ismotivated by the outcome of standard aug-mented Dickey Fuller (ADF) tests which donot reject the null of a unit root in the levelsof either series, but do reject the same nullwhen applied to the first-differences (at the

5-percent significance level).'"* Notice thatwhile my identification strategy hinges crit-ically on the presence of a unit root in pro-ductivity, it can accommodate both /(O)and /( 1 ) hours. Thus, and in order lo checkthe robustness of the results, I also estimatean analogous model for [Ax,, n,]', where n,denotes deviations of (log) hours from a fit-ted linear time trend.

Consistent estimates of the coefficients ofC(L) in (23) are obtained as functions of theestimated parameters of a reduced-form VARfor [Ax,, A«,]' , following a standard proce-dure.''' Given an estimate for C(L) (whichembeds the impulse response coefficients), es-timates of conditional correlations can be ob-tained using the following formula (with thepopulation coefficients are replaced by theircorresponding estimates):

(24) p(Ax,,An,\i)

for (• = z, m, where var(Ax,|O =and var(Art, /) ^ are con-

ditional variances of hours and productivitygrowth."^

III. Evidence

This section reports and discusses the evi-dence on conditional productivity-labor inputcomovements. First, 1 report evidence basedon a bivariate model estimated using postwarU.S. data. Then I show how the main quali-tative results obtained in that benchmarkmodel also hold for an augmented model thatincludes a number of monetary and financial

'•* Tables with a detailed description of unit root testscan be found in Galf (1996a) or in the Appendix availableupon request.

'' Detailed formulas for consistent estimator of CiL)in VAR models with recursive long-run restrictions canbe found in Galf (1996b) or in the Appendix availableupon request.

'" Of course, in practice the sums in (24) are truncatedat a large (but finite) lag.

258 THE AMERICAN ECONOMIC REVIEW MARCH 1999

variables (in addition to productivity andlabor-input measures), as well as for most ofthe remaining G7 countries.

A. Evidence from a Bivariate Model

The bivariate model (23) is estimatedusing U.S. quarterly data covering theperiod 1948:1-1994:4. The baseline seriesfor labor input is the log of total employee-hours in nonagricultural establishments("hours" ) . The baseline series for laborproductivity was constructed by subtractingthe previous variable from the log of GDP.In addition, I also report results obtained us-ing the log of the employed civilian laborforce ( " emp loymen t " ) as a labor-inputmeasure, with the corresponding productiv-ity measure constructed analogously. All se-ries were drawn from Citibase.

Table 1 reports estimates of both uncondi-tional and conditional correlations between thegrowth rates of each labor-input measure andthe corresponding measure of productivity.Standard errors are reported in parentheses,and significant estimates highlighted with one(10-percent level) or two (5-percent level)asterisks.'^ The first panel reports results basedon an estimated VAR model for [Ax,, An,]',with the second panel reporting the corre-sponding results based on the [Ax, , « , ] 'specification.

Estimates of the unconditional correlationof labor input and productivity are small,slightly negative, and only significant whenhours are used. As argued in Christiano andEichenbaum (1992) the absence of a largepositive correlation between those variablesconflicts with a key prediction of the basicRBC model driven by technology shocks, butcan in principle be reconciled with multiple-shock versions of the same model, since non-technology shocks are predicted to generate anegative correlation that may offset the posi-

' Standard errors for conditional correlations and im-pulse responses were computed using a Monte Carlomethod to sample from the estimated asymptotic distri-bution of the VAR coefficients and the covariance matrixof the innovations. Reported standard errors correspond tothe standard deviation of each statistic across 500 draws.

tive comovement induced by technologyshocks. Our benchmark estimates of the con-ditional correlations—reported in the secondand third columns—are, however, inconsis-tent with that explanation: in all cases, the es-timates point to a large negative correlationbetween the technology-driven components oflabor input and productivity growth, whereasthe corresponding nontechnology componentsdisplay a positive correlation. Furthermore,and with the exception of the specification us-ing detrended employment, all the estimatesare statistically significant at conventional lev-els. Figure 1 provides a graphical counterpartto the previous evidence, by displaying scat-terplots of the original productivity and hoursseries (in growth rates), as well as their tech-nology and nontechnology components recov-ered from the identified VAR."*

The previous results are, however, consis-tent with the predictions of models with im-perfect competition, sticky prices, and variableeffort, as exemplified by the stylized modeldeveloped in Section I. As shown there, theshort-temi rigidity in aggregate demand re-sulting from the stickiness of the price levelleads technology shocks to generate a negativecomovement between hours and productivity,while unobserved effort variations can accountfor the positive comovement induced by de-mand shocks.

In order to understand the source of the pre-vious results it is useful to look at the estimateddynamic responses of productivity, output,and hours to each type of shock. Figure 2 dis-plays the estimated impulse responses basedon the model with first-differenced hours, to-gether with their associated two-standard errorconfidence bands. In response to a positivetechnology shock of size equal to one-standarddeviation. labor productivity experiences animmediate increase of about 0.6 percent, even-tually stabilizing at a level somewhat higher.Output also experiences a permanent increase,but the initial rise appears to be more gradualthan that of productivity. The gap between the

'"The dramatic contrast between those estimates andthe predictions of standard RBC model can be by com-paring Figure 1 here to Charts 2 and 4 in Hansen andWright (1992).

VOL S9 NO. I GALi: TECHNOLOGY. EMPLOYMENT. AND THE BUSINESS CYCLE 259

TABLE I—CORRELATION ESIIMATHS;

Panel A: First-differenced laborHours

Employmeni

Panel B: Delrended laborHours

Employment

Unconditional

-0.26**(0.08)

-0.02(0.07)

-0.26**(0.08)

-0.02(0.07)

Technology

-0.82**(0.12)

-0.84**(0.26)

-0.81**(0.11)

-0.35(0.49)

Conditional

Nontechnology

0.26**(0.12)0.64**

(0.13)

0.35*(0.20)0.38

(0.56)

Nnic.-i: Table I reports estimates of unconditional and conditional correlations between the growth rates of productivityand labor inpul (hours or employment) in ihe United States, using quarterly data for the period 1948:1-1994:4. Standarderrors are shown in parentheses. Significance is indicated by one asterisk (10-percent level) or two asterisks (5-percentlevel)- Conditional correlation estimates are computed using the procedure outlined in the text, and on the basis of anestimated bivariate VAR for productivity growth and labor-input growth (Panel A) or productivity growth and detrendedlabor inpul (Panel B), Data sources and definitions can be found in the text.

initial increase in labor productivity and the(smaller) increase in output is reflected in ashort-lived, though persistent {and signifi-cant), decline in hours. The fact that the bulkof the joint variation in employment and pro-ductivity arising from a technology shocktakes place on impact, with both variablesmoving in opposite directions, is largely re-sponsible for the negative conditional corre-lation reported above.'''

Figure 2 also displays the estimated dy-namic responses to a nontechnology shock, asidentified by the empirical framework above.Such a shock is shown to have a persistentpositive effect on output, hours, and produc-

'•'A decline in hours (or. alternatively, an increase inunemployment) resulting from a positive technologyshock can also be detected in other structural VARs in theliterature. Since the purpose of those exercises is generallyunrelated lo the issue al stake here, the presence of sucha result often appears to go unnoticed or, at most, is brieflymentioned in the text. Some of the papers where that resultcan be found are: Blanchard (1989 Figure Lb). Blanchardand Quah (1989 Figure 6) , Gamber and Joutz ( 1993 Fig-ure I ). Blanchard et al, (1995 Figures C and D), Cooleyand Mark Dwyer (1995 Figure I ) . and Mario Fomi andLucrezia Reichlin ( I99.'i Figure 3 ). The latter two papersprovide a longer discussion of the finding, interpreling itas being consistent with the traditional Keynesian model.

tivity. Interestingly, while the effect on pro-ductivity vanishes over time (by assumption),the shock has a sizable (and statistically sig-nificant) permanent impact on both hours andoutput, thus emerging as the main source ofthe unit root detected in hours. The large pos-itive comovement of productivity and hours onimpact is the main source of the positive signin the estimated correlation conditional onnontechnology shocks reported in Table 1.

Most of the qualitative pattems in the im-pulse responses just presented are preservedwhen detrended hours (i.e.. deviations of loghours from a fitted linear time trend) areused in the estimated VAR, as displayed inFigure 3. The only significant difference liesin the absence (by construction) of a perma-nent effect of the nontechnology shock on thelevel of hours (and, consequently, on output,given the identifying restriction). Further-more, similar results (not reported) obtainwhen employment is used instead of hours asa labor-input measure.^"

" Impulse responses using employment data can befound in Galf (1996a Figure 3.b) and in the Appetidixavailable upon request.

260 THE AMERICAN ECONOMIC REVIEW MARCH 1999

ta-

1.3

10

OS

1.0 -

1(1 -

Data

°4 .1 .1

1.0

1.S -

-1.D .

-IJ -

.1.0 -

Tschnoloav ComDonant

^ • : :

NonOchnolofly Componwit

FIGURE I. PRODUfTiviTY vs. HOURS: DATA.

TECHNOLOC.Y COMPONENT, AND

COMP()NE.NT

B. Evidence from a Five-Variable Model

As a robustness check I estimate a higherdimensional (five-variable) VAR model,which allows for four orthogonal nontechnol-ogy shocks—still identified as shocks that donot have a permanent effect on the level oflabor productivity. Even though I make noattempt to identify each of those shocks sep-

arately (which would require imposing addi-tional, possibly controversial, restrictions),the estimated model provides interesting in-formation regarding the effects of technologyshocks on a larger number of variables thanwas the case for the bivariate VAR.

The specification considered uses data onmoney, interest rates, and prices, in additionto the productivity and lahor-input series usedin the bivariate model. My measure of thestock of money, denoted by m, is the (log) ofM2. The price measure (p) is the (log) of theconsumer price index (CPI). The nominal in-terest rate ( r) is the three-month Treasury Billrate, Because of limited availability of M2 datathe sample period begins at a later date (59:1-94:4).

In preliminary data analysis, standard ADFtests did not reject the null of a unit root inmoney growth (Am), inflation (Ap), and thenominal rate (r) at a 5-percent significancelevel, but did reject the same hypothesis fortheir respective first-differences, as well as forA(m, - /?,) (the growth rate of real balances).as well as r, - Ap, (the real interest rate).^'That characterization suggests estimating aVAR model for [Ax,, An,, Am, - Ap,, r, -Ap,, A^p,]'." Using (he estimated VAR, to-gether with the assumption that only technol-ogy shocks have a permanent effect on x, andthe orthogonality between technology andnontechnology shocks, one can recover esti-mates of the dynamic responses to a technol-ogy shock, as well as the components of thevariation in each time series associated withthose shocks a n d ^ a s a residual—^the sum ofthe components driven by the remaining fournontechnology shocks.

•' That characterization is consistent with the findingsof many other authors (see. e.g.. Shapiro and Watson[1988] and Gali [ 1992 ]). Detal Is of the tests can be foundin Table I of Galf (1996a) and in the Appendix availableupon request.

'- As a robustness check to make sure ihat none of thequalitative results hinged on the cointegration assumptionsimplicit in the specification of the VAR, I repeated theexercise using the estimates of a VAR "iti first-differences" (as would be appropriate in the absence ofcointegration), i.e.. a VAR for the five-variable vector[Ax,, An,, A'm,. Ar,, A'p,]'. The results obtained werevery similar to those reported in the text, and can be foundin the Appendix available upon request.

VOL 89 NO. I GAU: TECHNOLOGY. EMPLOYMENT. AND THE BUSINESS CYCLE

T«ehnotoBy Shock _ _ Nontechnology Shock

261

10 It 11

FlGURt; 2, ESTIMATKD IMPULSE RESPONSES FROM A BlVARlATE MoDbL: U,S. D A T A . FlR.ST-DlHKHRKNCED HOURS (PC)INTEST1MATK.S AND ± 2 STANDARD ERROR CoNHDENCt iNlliRVALS)

Table 2 displays the corresponding esti-mates of the productivity-labor input correla-tions conditional on each type of shock. Asbefore, I report results using both An, and n,in the estimated VAR. The estimates largelyconfirm the results from the bivariate model:technology shocks induce a high, statisticallysignificant negative correlation between pro-ductivity and hours (or employment), whereasthe (composite) nontechnology component ofthe same variables shows a positive correlation(also significant in three out of the fourspecifications).

Figure 4 displays the responses of a numberof variables to a technology shock. The pattemof responses of productivity, output, and em-ployment is very similar to that obtained in the

bivariate model: a positive technology shockleads to an immediate increase in productivitythat is not matched by a proportional changein output (the latter's response building upmore slowly over time), implying a transi-tory— though persistent^decline in hours.One small difference vis-a-vis Figures 2 and 3can be detected, however: the initial negativeeffect on hours is now more than fully reversedover time, leading to a positive, though quan-titatively small long-term effect.^'

-' That '"reversal" does not occur, however, when em-pk)yment is used as a labor-inpui measure (impulse —sponses not reported here).

re-

262 THE AMERICAN ECONOMIC REVIEW MARCH 1999

TKhndoay Shock Nontechnolofly Shock

FIGURE 3. ESTIMATED IMPULSE RESPONSES FROM A BIVARIATE MODEL: U.S. DATA. DETKLNDLD HOURS (POINTESTIMATES AND ±2 STANDARD ERROR CONFIDENT, INTERVALS)

Notice that the gradual response of outputparallels the slow buildup of real balances overtime. The response of the real rate to the im-provement in technology is positive and per-sistent, in accordance with theory, given thehigher returns to capital accumulation associ-ated with that improvement. Most interest-ingly, the estimates point to a persistentnegative impact on inflation (as opposed to aonce-and-for-ail drop in the priee level).While the direction of the price change is re-assuring (since it is consistent with the predic-tions of a broad class of models), the dynamicpattem seems consistent with the hypothesisof sluggish adjustment of prices over time,thus strengthening the "new Keynesian" in-terpretation suggested above.

C. Evidence from Other IndustrializedEconomies

This section reports estimates of produetivity-employment correlations for the remaining G7countries: Canada, the United Kingdom, Ger-many, France, Italy, and Japan.-^ For eachcountry I estimate a bivariate VAR model forproductivity and employment. The employ-ment measure is the (log) employed civilianlabor force, drawn from the OECD Quarterly

- Evidence for Spain using a related approach can befound in Gali (1996b), The intriguing results obtained inthat project were the main impulse behind the presentinvestigation.

VOL. 89 NO. I GALfj TECHNOLOGY, EMPLOYMENT. AND THE BUSINESS CYCLE 263

2—CONDITIONAL CORRELATION ESTIMATES:FlVE-VARIABLb MoDEL

Conditional on:

Panel A, Growth ratesHours

Employment

Panel B, DetrendedHours

Employment

Technology

-0.75**(0,04)

-0,82**(0,08)

-0,65**(0,05)

-0-88**(0.07)

Nontechnology

0.22**(0,09)0.29**

(0.08)

-0.02(0.02)0.26**

(0,01)

Notes: Table 2 reports estimates of conditional corre-lations between the growth rates of productivity andlabor input (hours or employment) in the United StatesStandard errors are shown in parentheses. Significanceis indicated by one asterisk (10-percent level) or twoasterisks (5-percent level). The conditional correlationestimates are based on the partially identified estimatedfive-variable VAR described in the text. The VAR isestimated using quarterly data for the period 1959:1-1994:4. and includes series for productivity, hours (or

employmeni), real balances, real interest rates, and in-flation. Panel A displays the results for the specificationIhat includes tabor-input growth. The results using de-trended labor input are shown in Panel B, Data sourcesand definitions can be found in the text.

Labor Foree statistics. The latter was sub-tracted from (log) GDP (drawn from theOECD Quarterly National Accounts) in orderto construct the series for (log) labor produc-tivity. Alt data are quarterly, and seasonallyadjusted. Sample periods vary across coun-tries, depending on data availability.^^

Standard ADF unit root tests were appliedto each series used.^" With one exception, thetests did not reject at the 5-percent significancelevel a unit root in the (log) levels of employ-ment and productivity. The exception was em-ployment in France, for which the unit rootnull was rejected. That led me to estimate a

-^The sample periods are as follows: Canada (62:1-94:4). the United Kingdom (62:1-94:3) . Germany(70:1-94:4). France (70:1-94:4). Italy (70:1-94:3).and Japan (62:1-94:4),

•" A more detailed discussion of those tests can befound in Galf (1996a) or in the Appendix available uponrequest.

VAR for [Ax,, n,] for France, and [Ax,, An,]for the remaining countries. Identification andestimation of conditional correlations pro-ceeds as in the bivariate U.S. model.

Table 3 reports, for each country, the esti-mated unconditional and conditional correla-tions of employment and productivity growth.The unconditional correlations are very smallin absolute value (and largely insignificant),with the exception of Italy (-0.47) . The av-erage correlation is -0 .11 . Thus, and in ac-cordance with the estimates based on U.S.data, there is no clear evidence of the largepositive correlations between productivityand employment predicted by the basic,technology-driven RBC model.

Most interestingly, the estimated condi-tional correlations for most countries displaythe same sign pattem as in the United States.Thus, and with the exception of Japan, the es-timates point to a negative correlation betweenthe technology components of employmentand productivity, with an average value of-0.56 (-0.75 if Japan is excluded). On theother hand, the nontechnology componentsshow a positive correlation (again, with ex-ception of Japan), which is significant in mostcases, and has an average value of 0.26 (0.43when Japan is excluded).^^

Figure 5 displays, for each country, the es-timated impulse responses of employment(solid line) and productivity (dashed line)to both types of shocks. With the exceptionof Japan, those responses show many of thequalitative features detected for the UnitedStates. In particular, the estimates point to apersistent decline in employment followinga positive technology shock, as well as anincrease in productivity accompanying anexpansion driven by a nontechnology shock.Nevertheless, some differences are evidentin a number of cases. Thus, technologyshocks seem to have larger and more persis-tent effects on employment in Germany, theUnited Kingdom, and Italy. By way of con-trast, in Canada the short-run negative im-pact of a positive technology shock on

•' Notice, however, that even though the paltem ofsigns of the conditional correlations is reversed for Japanthe estimates are nol statistically significant.

264 THE AMERICAN ECONOMIC REVIEW MARCH 1999

i 4. EsiiMATED IMPLILSB Ri-sPoNSiis ['KOM A FIVE-VARIABI.E MODEL: U.S, DATA. FIRST-DIFFHIENCED HOURS

(POINT ESTIMATES AND ±2 STANDARD ERROR CONFIDENCE iNTERVAt )

employment is fully reversed by the thirdquarter after the shock, and ends up havinga .strong positive effect asymptotically. Howshall one interpret those differences? Giventhat none of ihe employment responses to thetechnology shock are statistically significantin the long run, one may be templed to down-play the differences in point estimates.-** Al-ternatively, one may want to interpret thepersistence of those responses in some of theEuropean countries as evidence of ' hyster-

•*' A cotnplete set of itnpulse responses with confidenceintervals can be found in Galf (1996a).

esis" in labor markets, along the lines sug-gested hy Blanchard and Summers (1986).In a simple version of their model, wages areset in advance hy unions/insiders so that, inexpectation, next period's employmentequals current employment. As a result, anyshock that affects current employment willchange the level of employment perma-nently. That mechanism could also underliethe permanent effects on employment re-sulting from nontechnology shocks that areohserved in most countries, though moreconventional explanations are availahle inthat case, since those long-run effects mayresult from permanent shifts in the labor sup-

VOL 89 NO. I GAU: TECHNOLOGY. EMPLOYMENT. AND THE BUSINESS CYCLE 265

TABLL 3^<:()RRE-;LAT[()N ESTEMAIHS: INTLRNATIONAL EVIDENCE

Unconditional Conditional

Technology Nontechnology

Canada

United Kingdom

Germany

France

Italy

Japan

AverageAverage (excluding Japan)

-0.12*(0.08)

-0.11(0.13)0.08

(0,10)0.00

(0.11)-0.47**(0.12)

-0.07(0.08)

-0.11-0.12

-0.59*(0.32)

-0 .91**(0.16)

-0.55**(0.28)

-0.81**(0.27)

-0.93**(0.13)0,41

(0.47)

-0.56-0.75

0.57*(0.32)0.45**

(0.14)0.23**

(0.09)0.66**(0.29)0.27

(0.30)-0.60(0.42)

0.260.43

Notes: Table 3 reports estimates of unconditional and conditional correlations between thegrowth rates of prtxluclivity and employment fur Canada (62; I -94:4). the United Kingdom(62:1-94:3), Germany (70:1-94:4), France (70:1-94:4), Italy (70:1-94:3), and Japan(62:1-94:4). Standard errors are shown in parentheses. Significance is indicated by oneasterisk (lO-percent level) or two asterisks (5-percent level). The conditional correlationestimates are computed using the procedure outlined in the text on the basis of an estimatedbivariate VAR for productivity and employment growth (detrended employment forFrance). Data sources and exact definitions can be found in the text.

ply_whether exogenous (as in Shapiro andWatson, 1988), or induced by permanent fis-cal policy changes (as in Baxter and King,1983).

IV. Do Technology Shocks GenerateRecognizahle Business Cycles?

The bulk of the evidence in the previoussection focused on the joint comovement^—conditional and unconditional—of productiv-ity and labor-input measures. In this section Itum briefly to the corresponding comovementsbetv 'een output and labor input.

A strong positive comovement of GDPand labor input is a central feature of busi-ness cycles in industrialized economies. Anytheory of business cycles which failed tocapture that feature would be viewed as em-pirically irrelevant and would arise little at-tention from the profession, so it is thus notsurprising that a high positive correlation ofoutput and hours lies among the key predic-tions of the basic RBC model driven by tech-

nology shocks. Yet, whether technologyshocks in actual economies are responsiblefor the pattern of GDP and labor-input fluc-tuations associated with business cycles re-mains an open question, and one whichshould provide a critical test of the relevanceof a research program that aims to interpretthe bulk of aggregate fluctuations as result-ing from those shocks. The empirical frame-work developed above can address thatquestion by allowing one to decompose thehistorical time series for GDP and hours (oremployment) into technology and nontech-nology shocks.

The outcome of that exercise is displayed inFigure 6. In order to save space, I report onlyresults for the United States, based on the bi-variate VAR for [Ax,, An,]'. The figures dis-play the estimated components of (log) GDP(solid line) and (log) hours (dashed line), af-ter being detrended (expost) using a HP filter(\ = 1600) in order to emphasize fluctuationsat business-cycle frequencies. In addition, thefigures highlight as vertical lines the nine

266 THE AMERICAN ECONOMIC REVIEW MARCH 1999

Cwiscli: tichnoto« •hoeh ._ Cwidi: nonttclwology •hock

<l -

0 1

B I

0 4 .

u .

DO -

OJ -

/

/

- - - - _

i < 1~"i—T"

^ ^ ^ ^

~i—i~

- - - •

"T T""T—io~"7i ii

U.K.: nofilKhnology •hoeh

kn -

OM •

UI •

«§•

«•• .

\\

\ _

-—^

i 1

//

k 1

' "

— •

i i k

—

t » 1 li

Owmany: tKhnotogy shock

FIGURE 5. ESTIMATKD IMPULSE RESPONSHS OF EMPLOYMENT (SOLID LINE) AND PRODUCTIVITY (DASHKU LiNb)

OTHI-R INDUSTRIALIZED ECONOMIES

NBER-dated postwar recessions. The pattemsIhat emerge are quite revealing in a number of

Consider the fluctuations that the empiricalmodel identifies as having resulted from tech-nology shocks (top chart). The pattems dis-played by the two series hardly match any of

-" Results for most olher specifications and countriesare qualitatively similar. In particular, an utmost identicalpicture emerges when detrended hours are used in theVAR specification (see Appendix available upon re-quest), which implies that the results reported here do nothinge on my allowing for permanenl effects of nontech-nology shocks on both output and hours.

the postwar cyclical episodes. That feature isparticularly true in one dimension: the strongpositive comovement of GDP and employ-ment that is generally viewed as central char-acteristic of business cycles is conspicuouslyabsent here; in fact, the estimated correlationbetween the two series is -0.02.

A look at the nontechnology components ofthe GDP and hours series (bottom chart)yields a completely different picture. First,such shocks are seen to have had a dominantrole in postwar U.S. fluctuations. Second, theestimates point to an unambiguous pattem ofpositive comovements of GDP and hours as-sociated with those nontechnoiogy shocks,with an estimated correlation of 0.97. Third,

VOL 89 NO. I GAU. TECHNOLOGY, EMPLOYMENT. AND THE BUSINESS CYCLE 267

Fnnce: tachnology thochFranca: nontochnoloflr alwck

ID 11 13

. « .

Q M -

0.40 -

DDD -

«.4O - 6 1 i

Japan:

^ . '

— i — ;

(achnokigy ahock

—J—i—1—r 10 n ta

01 -

01 -

01 '

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//

11

11

1

Japan:

- ^

\

nontachnology ahock

^ - -

i i i k • ID 11 13

FIGURE 5. Continued

the resulting fluctuations account for the bulkof the decline in GDP and hours associatedwith postwar recessions.

V. Can the Evidence be Reconciled with theRBC Paradigm?

The above results strongly suggest that U.S.business cycles have been largely driven bydisturbances that do not have permanent ef-fects on labor productivity. To the extent thatonly technology shocks can account for theunit root in the latter variable, those resultsseem to provide a picture of U.S. business cy-cles that is in stark contrast with the one as-sociated with RBC models. That conclusionmay be strengthened by examining (and trying

to refute) two arguments that have often beenraised in order to reconcile the previous evi-dence with the RBC paradigm.

First, one might argue that the shocks thathave been labeled all along as "nontechnol-ogy" shocks might also be capturing transi-tory shocks to technology, since the latterwould generally have no permanent effect onthe level of productivity. While there is noth-ing logically wrong with that interpretation, itcan hardly provide any support for RBC mod-els. For one thing, it is hard to understand howshocks to technology could be transitory, anobservation which seems to conform with thefailure to detect a significant transitory com-ponent in measures of total factor productivity(TFP) growth, which, to a first approximation.

268 THE AMERICAN ECONOMIC REVIEW

TechtTOlogy Component f HP-filtered)

MARCH

4B 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93

Notitechnology Component (HP-Mered)

48 51 54 57 60 63 66 69

FIGURE 6. ESTIMATED TECHNOLOOY AND NONTECMNOUXJY COMPONKNTS OF U.S. GDP AND HOURS

can he characterized as white noise."' Most im-portantly, such an interpretation leaves unan-swered why permanent technology shockswould have the effects on the economy thatare reflected in the estimated conditional cor-relations and impulse responses reportedabove.^'

^ This characterizaiion seems lo hold even when pos-sible vanalions in inputs utili/.ation rates are accuunted tor{see, e.g., Bumside and Eichenbaum. 1996).

" Nonslandard RBC inudcl;, chLtfacterized by slowtechnology diffusion may generate ii negative response otemployment to a positive technology shock (see, e.g.,Hairault et ai., 1995) because ot a doniinani wealth effect(thm makes people be willing to consume more leisure).That mechanism is, in my view, little plausible (in addi-tion Io being in conflict with the observed lime-seriespropenies of mullifactor productivity).

Second, multisectoral RBC models with id-iosyncratic technology shocks and lags in thereallocation of labor across sectors are likelyto imply a short-term decline in aggregate em-ployment in the wake of a positive technologyshock in one sector (reflected in aggregateTFP). thus inducing a negative comovementconsistent with the estimates above. In thatcontext, however, the pattem of conditionalcorrelations signs predicted hy the RBC modelshould still be present in sectoral data, an im-plication that is in principle testable. Estimatesof such correlations based on two-digit U.S.manufacturing data have recently been ob-tained by Michael T. Kiley ( 1997) using anidentified VAR model lor employment andproductivity growth based on the one pro-posed and estimated in the present paper.Kiley's estimated correlations between the

89 NO. I GAU: TECHNOLOGY, EMPLOYMENT. AND THE BUSINESS CYCLE 269

technology-driven components of those vari-ables tum up negative for the vast majority ofindustries (15 oul of 17) and quite high in ab-solute value (average = -0.58). The corre-sponding estimates for the nontechnologycomponents are mostly positive (11 out of 17industries), with an average value of 0.20.Kiley's sectoral results are thus clearly notsupp<.>rtive of a "multisectoral RBC" expla-nation for the aggregate evidence provided inthis paper.

VI. Summary and Conclusion

In recent years, many macroeconomistshave been attracted by the hypothesis that ag-gregate fluctuations can be explained, at leastto a first approximation, as the economy's re-sponse to exogenous variations in technology.That view is often justified by the (largely rec-ognized ) ability of RBC models to generateunconditional moments for a number of mac-roeconoinic variables that display patternssimilar to their empirical counterparts.

The present paper has provided some evi-dence that questions the empirical merits ofthat class of models.'' The paper builds on theobservation of a near-zero unconditional cor-relation between productivity and employ-ment, both in the United States and in manyother industrialized economies. Proponents ofRBC models have interpreted thai evidence asreflecting the coexistence of technologyshocks with other shocks. Yet. and to the ex-tent that technology shocks are a significantsource of fluctuations in those variables, wewould expect RBC models to provide at leastan accurate description of the economy's re-sponse to such shocks. For the majority of theG7 countries, however, the estimates of the ef-fects of technology shocks yield a picturewhich is hard to reconcile with the predictionsof those models: positive technology shockslead to a decline in hours, and tend to generate

' Basu el al. ( 1997) obtain simitar results using an un-relalcd approach: they look al the response of inpuls to aninnovalion in a "muditicd Solow renidual" series, whereEhe inodificalion aiicmpti to correct for the bias aswciaicdwith increasing returns, imperfect competition, variableutilization, and sectoral real locations.

a negative comovement between that variableand productivity. On the other hand, nontech-nology shocks are shown to generate a positivecomovement between hours and productivity,in contrast with the negative comovement pre-dicted by RBC models with multiple shocks.

The results are, however, consistent with aclass of models with imperfect competition,sticky prices, and variable effort. In thosemodels—a stylized version of which has beenpresented in Section 1—the combination ofprice rigidities and demand constraints leadsfirms to contract employment in the face of anexogenous increase in multifactor productiv-ity, whereas the presence of variable effortaccounts for the rise in measured labor pro-ductivity in response to a demand-induced ex-pansion. Needless to say. the nature ofaggregate fluctuations and the potential rolefor policy associated with such an economyare very different from those identified withthe RBC paradigm.

REFERENCES

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