Nber Working Paper Series Business Cycle Accounting

The authors thank the National Science Foundation for support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. ABSTRACT We propose and demonstrate a simple method for guiding researchers in developing quantitative models of economic fluctuations. We show that a large class of models are equivalent to a prototype growth model with time-varying wedges that resemble time-varying productivity, labor taxes, and capital income taxes. We use data to measure these wedges, called efficiency, labor, and investment wedges, and then feed their measured values back into the model. We assess the fraction of fluctuations in output, employment, and investment accounted for by these wedges during the Great Depression and the 1982 recession. For the Depression, the efficiency and labor wedges together account for essentially all of the fluctuations; investment wedges play no role. For the recession, the efficiency wedge plays the most important role; the other two, minor roles. These results are not sensitive to alternative measures of capital utilization or alternative labor supply elasticities. We propose and demonstrate the use of a simple method for guiding researchers in developing quantitative models of economic fluctuations. Our method has two components: an equivalence result and an accounting procedure. The equivalence result is that a large class of models, including models with various frictions, are equivalent to a prototype growth model with time-varying wedges which, at least at face value, look like time-varying productivity, labor taxes, and capital income taxes. For example, we show that an economy in which the technology is constant but input-financing frictions vary over time is equivalent to a growth model with time-varying productivity. We show that models with sticky wages and monetary shocks or unions and antitrust policy shocks are equivalent to a growth model with time-varying labor taxes, and a model with investment-financing frictions and wealth redistribution shocks is equivalent to a growth model with time-varying capital income taxes. These examples lead us to label the time-varying wedges efficiency wedges, labor wedges, and investment wedges. Our accounting procedure begins by using …