Abstract

Labor productivity in modern industrialized countries is procyclical. Three different explanations for this empirical observation have been proposed in the literature: 1) technological shocks, 2) labor hoarding, and 3) increasing returns to scale in production. Combining elements by Hornstein (1993) and Burnside et al. (1993), we integrate these features in a real business cycle model that is calibrated to match empirical observations on German data. We allow for two types of shocks, a technology shock and a shock to government consumption. Our main results can be summarized as follows: 1) Technology shocks are indispensable as a source of fluctuations in labor productivity Shocks to government demand alone do not generate procyclical productivity even with increasing returns to scale. 2) Labor hoarding appears to be important in explaining the cyclical behaviour of productivity and employment. 3) Increasing returns mainly result in a strong reduction of the size of the technology shock necessary to reproduce the observed volatility of output.