Assessing the Empirical Relevance of Labour Frictions to Business Cycle Fluctuations

Abstract

This paper describes a dynamic stochastic general equilibrium model augmented with labour frictions, namely: indivisible labour, predetermined employment and adjustment costs. This improves the fit to the data as shown by a higher log marginal likelihood and closer match to key business cycle statistics. The labour frictions introduced are relevant for model dynamics and economic policy: the effect of total factor productivity shocks on most macroeconomic variables is substantially mitigated; fiscal policy leads to a greater crowding out of private sector activity and monetary policy has a lower impact on output. Labour frictions also provide a better match to impulse response functions from vector autoregressive models.

Learning by doing, organizational forgetting, and the business cycle

“…The results in this paper help to address both these issues. Other internal propagation mechanisms previously considered in the modeling of labor markets in business cycle models include labor hoarding (Burnside et al, 1993), learning by doing Chang et al (2002), and overtime labor (Madeira, 2014(Madeira, , 2018.…”