Supply and Demand in the Aggregate Labor Market: A Structural VAR Analysis

Abstract

This paper examines the puzzling correlation between real wages and hours worked in a sticky wage model with two shocks. one aggregate demand and one supply. I estimate the response of real wages to the shocks with a VAR under a long-run restriction on real wages. It is shown that the response of real wages to the aggregate demand shock is countercyclical and to the aggregate supply shocks is procyclical. The variance decomposition shows that aggregate demand shocks are important. The results are consistent with the implications of the sticky wage model, and the model can explain with the near zero correlation between wages and hours worked.