Labor Markets II Labor Markets and the Business Cycle

What do we mean by “The Business Cycle”?

Real GDP:

What do we mean by “The Business Cycle”? Since WWII, real GDP in the US has grown an average of 3% per year.

Real GDP:

What do we mean by “The Business Cycle”? Since WWII, real GDP in the US has grown an average of 3% per year. However, sometimes GDP grows faster than 3% (expansions) while at other times, it grows slower than trends (contractions)

GDP: Deviations from trend

Characteristics of Business Cycles When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables. Correlation (procyclical, countercyclical) Timing (leading, coincident, lagging) Relative Volatility

GDP

GDP and Employment

Labor Markets and the Business Cycle Employment is procyclical and is coincident with the cycle

GDP

GDP and Real Wages

Labor Markets and the Business Cycle Employment is procyclical and is coincident with the cycle Real wages are procyclical

GDP

GDP and Labor Productivity

Labor Markets and the Business Cycle Employment is procyclical and is coincident with the cycle Real wages are procyclical Labor Productivity is procyclical and leads the cycle

Labor Markets and the Business Cycle Employment is procyclical and is coincident with the cycle Real wages are procyclical Labor Productivity is procyclical and leads the cycle Unemployment is countercyclical

Can our model explain these labor market facts? Suppose that we assume the business cycle is caused by random fluctuations in labor supply. Can this explain the correlations in the labor market?

Can our model explain these labor market facts? Suppose that we assume the business cycle is caused by random fluctuations in labor supply. Can this explain the correlations in the labor market? An increase in labor supply lowers the real wage while increasing output and employment

Can our model explain these labor market facts? Suppose that we assume the business cycle is caused by random fluctuations in labor supply. Can this explain the correlations in the labor market? An increase in labor supply lowers the real wage while increasing output and employment Countercyclical real wages are inconsistent with the facts.

Neoclassical (Supply Side) Economics Neoclassical economics assumes that expansions/recessions are caused by random increases/decreases in productivity

Neoclassical (Supply Side) Economics Neoclassical economics assumes that expansions/recessions are caused by random increases/decreases in productivity A positive productivity shock (which increases labor demand) creates a positive correlation between output, wages, employment and productivity. This is consistent with the data.

Wealth Effects? Recall that if higher wages are perceived to be permanent, then labor supply starts to decrease. This would create larger wage effects and smaller employment effects – this is not what the data suggests

Intertemporal Substitution Intertemporal substitution suggests that individuals exploit temporary wage increases by working more (Make hay while the sun shines!)