Sensitivity of Impulse Responses to Small Low Frequency Co-movements: Reconciling the Evidence on the Effects of Technology Shocks

We clarify the empirical source of the debate on the effect of technology shocks on hours worked. We argue that the contrasting conclusions from level and difference VAR specifications are not primarily due to the presence or absence of a unit root in hours worked. Rather they are due to a small, but important, low frequency comovement between hours worked and labour productivity growth. This comovement is allowed for in the levels specification, but assumed away in the difference VAR. Our theoretical analysis shows how the empirical results from both side of the debate can be reconciled.