Revisiting and Rethinking the Business Cycle Okun’s Law, Productivity Innovations, and Conundrums in Business Cycle Dating

A long tradition in macroeconomics dating
back to Arthur Okun (1965) and Walter Oi
(1962) regards cyclical productivity fluctuations
as an artifact, a residual generated from the
incomplete and lagged response of employment
and labor hours to demand-driven fluctuations
in real output. In Okun’s version a one percent
decline in output relative to trend is divided
up into a reduction of 1 ⁄3 point in productivity
and 2 ⁄3 point in aggregate hours. The latter
is further subdivided into a reduction of 1 ⁄3
point in the employment rate, with the remaining
adjustment taking the form of lower hours
per employee and in the labor force participation
rate (hereafter LFPR). Yet this tradition
of regarding cyclical productivity fluctuations
as a byproduct of demand-driven output cycles
has been almost forgotten over the past three
decades as a result of widespread adoption of
the real business cycle (RBC) model in which
productivity shocks are treated as exogenous, as
unexplained, as unrelated to aggregate demand,
and as the sole driver of business cycles. Even
in the more enlightened modern macro work
on Dynamic Stochastic General Equilibrium
Models, aggregate demand and sticky prices
have reappeared, but most recent papers still
include an autonomous “technology shock” as
one of several causes of short-term business
cycle fluctuations.

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