March 12, 2007
Naomi N. Griffin
Previous studies have identified a significant drop in the volatility of the U.S. GDP and other measures of aggregate activity since the mid-1980s. Yet uncertainty remains as to whether the reduced size and frequency of macroeconomic shocks, or the economy’s reduced responses to shocks, are producing aggregate economic stability. To investigate this issue, this paper looks at the changes in aggregate employment responses to shocks. Using an interrelated factor demand model, this paper finds that the monthly employment elasticity to unanticipated demand shocks has declined by more than 80% in the manufacturing industry since 1984 in comparison with the elasticity during prior decades. Similarly, the work-hour elasticity to unanticipated demand shocks declined by more than 60%. At the same time, the paper does not find any observable change in the pattern of inventory adjustment, except in its responses to future demand. Using vector autoregressions (VARs), the paper also finds that the dynamic responses of employment to some measures of aggregate economic shocks, such as oil shocks and monetary policy shocks, are smaller and less volatile since 1984. This result holds for both manufacturing at monthly frequency and aggregate employment series at monthly and quarterly frequencies.