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.
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We thank the attendees at the Macro Lunch at Wharton who made fundamental contributions to this project. We benefited from conversations with Urban Jermann, John Knowles, and especially Se Kyu Choi. We also thank Andrés Erosa, Jonas Fisher, Gary Hansen, Claudio Michelacci, Josep Pijoan-Mas, and seminar participants at the Bank of Canada, the Bank of Portugal, the Federal Reserve Bank of Atlanta, the Federal Reserve Bank of Minneapolis, the London School of Economics, the Economic Dynamics Conference in Honor of Edward Prescott at the University of Tokyo, Seoul National University, University of California Santa Barbara, Universitat de València, and the 2008 ADRES/EDHEC conference on “Labor Market Outcomes: A Transatlantic Perspective.” Ríos-Rull thanks the National Science Foundation (Grant SES-0079504 ) and the Penn Research Foundation for support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis, the Federal Reserve Bank of St. Louis, or the Federal Reserve System.