## What Prevents a Real Business Cycle Model from Matching the U.S. Data? Decomposing the Labor Wedge

_IMF Working Papers, September 8, 2017_

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## Bibliographic details
- Authors: Dmitry Plotnikov
- Published: September 8, 2017
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484318584.001

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### Methodology and Data Transformations
- Business cycle accounting exercise following Chari, Kehoe and McGrattan (2007).
- Data measured in wage units following Farmer (2010).
- Analysis covers the entire postwar period.
- Approach preserves common medium-term business cycle fluctuations in GDP, its components, and the unemployment rate (contrasting with conventional filtering approaches that remove medium-frequency fluctuations).
- Decomposition of the labor wedge into:
  - labor supply wedge, and
  - labor demand wedge.

### Main Findings
- In the transformed (wage-unit) data, most movements in GDP are accounted for by the labor supply wedge.
- This result reverses a central finding of the real business cycle literature that "70% or more" of economic fluctuations can be explained by TFP shocks.
- Conclusion: the real business cycle model fits the U.S. data poorly because the assumption that households are on their labor supply equation is flawed.
- The poor fit of the real business cycle model is masked when data are filtered with conventional approaches that remove medium-frequency fluctuations.

### Interpretation and Theoretical Consistency
- The evidence points to problems in representing household behavior via the standard labor supply equation used in RBC models.
- Findings are consistent with the literature on incomplete labor markets.

### Key Concepts and Keywords Emphasized
- business cycle, business cycles
- equilibrium unemployment
- Labor demand; Labor supply; labor supply wedge; labor wedge
- production function
- standard deviation
- TFP fluctuation; TFP shock
- Unemployment; Unemployment rate
- wage series; wage unit; Wages

*Source: Dmitry Plotnikov, IMF Working Paper, September 8, 2017.*

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_Source: https://www.imf.org/en/publications/wp/issues/2017/09/08/what-prevents-a-real-business-cycle-model-from-matching-the-u-s-45211_