Real Business Cycles with a Human Capital Investment Sector and Endogenous Growth: Persistence, Volatility and Labor Puzzles

By Jing Dang, Max Gillman and Michal Kejak

A positive joint two-sector productivity shock causes Rybczynski (1955) and Stolper and Samuelson (1941) effects that release leisure time and initially raises the relative price of human capital investment so as to favor it over goods production. This enables a basic RBC model, modified by having the household sector produce human capital investment sector, to succeed along related major dimensions of output, consumption, investment and labor, similar to the international approach of Maffezzoli (2000). By modifying the dynamics relative to the important work of Jones et al. (2005), two key US facts stressed by Cogley and Nason (1995) are captured: persistent movements in the growth rates of output and hump-shaped impulse responses of output. Further, physical capital investment has data consistent persistence within a hump-shaped impulse response. And Gali’s (1999) challenging empirical finding that labour supply decreases upon impact of a positive productivity shock is reproduced, while volatility in working hours is also data-consistent because of the substitution between market and nonmarket sectors.

About ten years ago, many papers were trying to provide an internal propagation mechanism to the canonical RBC model in order to answer to Cogley and Nason (1995). Then Galí (1999) posed the next challenge before the first one was, to my mind, resolved. It looks like this paper actually makes progress on both fronts.

4 Responses to Real Business Cycles with a Human Capital Investment Sector and Endogenous Growth: Persistence, Volatility and Labor Puzzles

  1. M. H. says:

    I am surprised to see Gali’s AER paper mentioned here. I thought it had been shown several times to be methodologically wrong and that Monte Carlo experiments with traditional RBC models would yield exactly his result with his specification. That seems like a non-issue to me.

  2. Max Gillman says:

    I think it is still controversial. Consider the more recent paper by Gali that reinforces his 1999 findings: Galı, J.: 2004, On the role of technology shocks as a source of business cycles: some new evidence, Journal of European Economic Association 2, 372-380.
    First he argues that his 1999 technology shock identification is robust. Then he finds again an initial negative effect of productivity shocks on employment. Qualifications have to do with whether the TFP shock is temporary or permanent. In the RBC standard framework, it is temporary, of course. However with an identical shock to human capital investment productivity, the shock has a permanent component as well. This causes the market sector employment to fall, as in Gali’s work, yet not in a way that invalidates the RBC approach. The effect is the opposite: of showing that the RBC model can show such effects through the human capital sector.

  3. Jabbadoo says:

    Gali’s paper have never addressed the Monte Carlo experiments. He just ignores them.

    • Max Gillman says:

      I appreciate the point that Gali does not address the issues raised brilliantly by Chari, Kehoe, and McGrattan 2008 [“Are structural VARs with long-run restrictions useful in developing business cycle theory?,” JME,55(8): 1337-1352.] However there remains controversy even on their approach (Christiano, Lawrence J., and Joshua M. Davis, 2006. “Two Flaws In Business Cycle Accounting,” NBER Working Papers 12647.) The main issue from my perspective is that an exogenous growth model will not in general give the same impulse responses as a two-sector endogenous growth model, and it is a question of whether we try to fit all of our data results into some set “box” (exogenous growth), or whether we consider slight but mainstream extensions/generalizations such that an economy-wide productivity shock can have both temporary (through the goods sector) and permanent (through the human capital sector) effects on output levels.

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