r to identify different supply contributions, namely those coming from employment and those coming from productivity, additional identification criteria must be introduced. Stock and Watson use long run restrictions implied by the neoclassical growth model for that task. The neoclassical growth model appears to be suitable, since there are at least three important features in the long run trends which are compatible with this model:
В· A close trend correlation between the growth of labour productivity and capital intensity.
В· Capital intensity and productivity grow at a similar rate in the long run.
В· If one looks over long periods of time and across the EU and the US, the employment rate appears to be unrelated with productivity growth.
Using the neoclassical growth model this leads to the imposition of the following long run restrictions:
В· The labour market shock can have short and long run effects on employment, productivity and inflation.
В· The productivity shock can have long run effects on productivity and inflation but only short and medium run effects on employment. This constraint arises from the assumption that real wages are indexed to productivity in the long run.
В· The demand shock can have a long run effect on inflation only but not on employment and productivity. No long run constraint is imposed on inflation. p> These three types of restrictions imply a triangular long run structure between the growth rate of employment (), productivity () and inflation () on the one hand and the corresponding shocks to employment (v), productivity (e) and demand (d) on the other. If one defines the vector
В
and the vector, then the moving average representation of this model is given by:
with
where the matrix A (1) shows the long run restrictions. Note, this particular structure is particularly suited to test for the short, medium and long run effects of an employment shock. Allowing for a non-zero long run productivity effect of an employment shock allows one to test for labour quality effects associated with a permanent change in the employment rate. A similar analysis of the employment effects of productivity shocks has been conducted by Gali (1999).
The empirical results are presented in two steps. In step one, the impulse responses from the estimated VAR are presented. These responses give the impact on employment and productivity of a unit shock to employment, productivity and demand. Recall that the identifying restrictions imply that temporary unit shocks to employment can have permanent effects on employment and productivity, while a unit shock to demand (Inflation) can only have temporary effects. p> In order to evaluate the quantitative magnitudes of these shocks, they are compared to similar shocks simulated with the Euro area QUEST model. This comparison is useful since it shows whether orders of magn...
