Many empirical tests of the intertemporal, substitution theory of labor market fluctuations have assumed that shocks to the labor demand curve are the sole source of variance in hours and wages. We show that conclusions based on these tests are very sensitive to small deviations from this extreme case. Using data generated by a standard real business cycle model, we show that standard methods incorrectly reject the intertemporal substitution theory even when demand curve shocks account for over 90% of the variance in wages and hours.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics
- Control and Optimization
- Applied Mathematics