Labor-Supply Shifts and Economic Fluctuations

We investigate the role of labor-supply shifts in economic fluctuations. A new VAR identification scheme for labor supply shocks is proposed. According to our VAR analysis of post-war U.S. data, labor-supply shifts account for about half the variation in hours and one-fifth of variation in aggregate output. To assess the role of labor-supply shifts in a more structural framework, estimates from a dynamic stochastic general equilibrium (DSGE) model with stochastic variation in home production technology are compared to those from the VAR. To obtain a VAR identification scheme that is consistent with the DSGE model, we cannot solely rely on ``zero-restrictions''. Instead we indirectly specify a proper prior distribution for impulse responses and variance decompositions and update it through the sample information. Our method provides an alternative to recently proposed identification schemes that rely on inequality restrictions on the direction of impulse responses.