Employment and output dynamics in a model with social interactions in labor supply

A particular challenge for the macroeconomic models is their inability to match the joint dynamics of employment, wage and output observed in the data. In this paper, we incorporate labor-leisure externalities into a standard model, as supported both by recent empirical studies in labor economics as well as social psychology, where the marginal disutility of an extra labor hour supplied decreases with the average work hours by the society. This generates a social multiplier effect which ampli.es the responses of employment and output to exogenous shocks. Our model, consistent with the implications of both microeconomic and macroeconomic studies for the elasticity of labor supply, offers quantitative improvement over existing studies in two dimensions in terms of matching the observed dynamics in the U.S. data in the post World War II period: First, we get considerable improvements for the employment, wage and output volatilities in response to technology and government expenditure shocks compared to a model without social interactions. Second, we obtain a weak co-movement between employment and average labor productivity, unlike the existing studies.