Redistributive shocks and productivity shocks

A productivity innovation reduces labor share at impact, making it countercyclical; it subsequently produces a long-lasting increase that peaks five years later at a level larger in absolute terms than the initial drop, before slowly returning to average, i.e., labor share overshoots. We estimate a bivariate shock process to the production function that under competition in factor markets accounts for this overshooting. We pose this process in an otherwise standard real business cycle economy, and we find that the contribution of productivity innovations to the variance of hours is 1% of that in the standard RBC model.

Research highlights► Labor share overshoots in response to productivity innovations. ► An estimated bivariate shock to the production function, under the assumption of competition in factor markets, accounts for the overshooting of labor share. ► Independently of the Frischian elasticity of labor supply, the volatility of hours worked in the bivariate shock economy is much smaller than that in the standard univariate shock economy. ► The dynamic overshooting response of labor share to productivity almost entirely eliminates the ability of real business cycle models to deliver model-generated hours that resemble actual data.