Business Cycle Accounting

Abstract

We propose a simple method to help researchers develop quantitative models of economic fluctuations. The method rests on the insight that many models are equivalent to a prototype growth model with time-varying wedges that resemble productivity, labor and investment taxes, and government consumption. Wedges that correspond to these variables-efficiency, labor, investment, and government consumption wedges-are measured and then fed back into the model so as to assess the fraction of various fluctuations they account for. Applying this method to U.S. data for the Great Depression and the 1982 recession reveals that the efficiency and labor wedges together account for essentially all of the fluctuations; the investment wedge plays a decidedly tertiary role, and the government consumption wedge plays none. Analyses of the entire postwar period and alternative model specifications support these results. Models with frictions manifested primarily as investment wedges are thus not promising for the study of U.S. business cycles. Copyright The Econometric Society 2007.

Quantifying Confidence

“…Suppose first that one approaches the data generated by our model through the lenses of the RBC model augmented with various wedges, as suggested by Chari, Kehoe, and McGrattan (2007). In 21 Throughout this section, we have focused attention on comparing features of the data to theoretical counterparts that do not require us to parameterize the standard deviation of either the confidence shock or the technology shock: the IRFs seen in Figure 1, and the conditional correlations and relative volatilities reported in Table 1 are invariant to the choice of σ ξ and σa.…”

“…We now turn attention to the estimation of the wedges US data. This is done in a similar fashion as in Chari, Kehoe, and McGrattan (2007). The estimation is based on the baseline RBC model, augmented with ad hoc stochastic processes for the following four wedges: an efficiency wedge, τ e t , a labor wedge, τ n t , a capital wedge, τ k t , and a resource wedge τ g t .…”

“…As in Chari, Kehoe, and McGrattan (2007), we assume that the vector T t = (τ eA "generic" DSGE model. We henceforth consider an economy whose equilibrium is represented by the following linear dynamic system:…”

The Labor Wedge: MRS vs. MPN

“…As Chari, Kehoe, and McGrattan (2007) have shown, there are many underlying models that equivalently yield a gap τ t between the MPN and the MRS. The idea here is to explore which of the two components, τ f t or τ h t , is mostly responsible for business cycle movements of the labor wedge τ t .…”

“…The labor wedge is defined as the gap between these two objects (Hall, 1997;Mulligan, 2002;Chari, Kehoe, and McGrattan, 2007;Shimer, 2009). Contrary to the prediction of the neoclassical growth model, the labor wedge, when measured under standard aggregate production function and utility function of a representative household, varies significantly over the business cycle and in a countercyclical way to output.…”