Staff Reports

Consumption Heterogeneity, Employment Dynamics, and Macroeconomic Co-movement

Previous title: "Labor Supply Heterogeneity and Macroeconomic Comovement"
October 2009Number 399
Revised September 2013
JEL classification: E13, E24, E32

Authors: Stefano Eusepi and Bruce Preston

Real-business-cycle models necessarily rely on total factor productivity shocks to explain the observed co-movement between consumption, investment, and hours. However, an emerging body of evidence identifies "investment shocks" as important drivers of business cycles. This paper shows that a neoclassical model consistent with observed heterogeneity in labor supply and consumption across employed and nonemployed can generate co-movement in response to fluctuations in the marginal efficiency of investment. Estimation reveals that these shocks explain the bulk of business-cycle variance in consumption, investment, and hours. A corollary of the model's empirical success is that the labor wedge is not important at business-cycle frequencies.

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