By Loukas Karabarbounis
A parsimonious model with home production, estimated to match moments of the “labor wedge,” explains prominent puzzles of the international business cycle. If market and home activity are substitutes, then the measured labor wedge increases whenever market consumption and employment decrease. Home production breaks the tight negative link between market consumption and its marginal utility and therefore helps explain the international risk sharing puzzle. In an estimated two-country dynamic general equilibrium model in which the labor wedge is endogenously generated to match its empirical moments, market output and market employment are more correlated than market consumption and investment across countries, relative market consumption is negatively related to the real exchange rate and real net exports are countercyclical. Further, the international risk sharing puzzle becomes easier to explain as the degree of financial completeness increases.
Interesting paper that manages to resolve several papers in the international business cycle literature in one go by introducing home production into the standard model, along with estimated labor wedges. The latter does not quite follow the traditional procedure, and it would be interesting to see how the model would have done without the wedges, or at least with a fully calibrated model.