Abstract
This paper …rst documents the increase in the time lag with which labor
input reacts to ‡uctuations in GDP and its driving structural shocks (“the
labor adjustment lag”) that is visible in US data since the mid-1980s. We show
that lagged labor adjustment is optimal in a setting where there is uncertainty
about the persistence of shocks and where labor input is costly to adjust.
We then present evidence that both the nature of shocks hitting the economy
as well as labor adjustment costs may have changed during the 1980s in a
direction that could explain the observed increase in the lag. Finally, we argue
that the increase in the labor adjustment lag has the potential to explain
some macroeconomic puzzles that characterize post-1984 US data, such as
the reduced procyclicality of labor productivity and the reduction in output
volatility (known as the Great Moderation).
Key words: imperfect information, labor adjustment, jobless growth, option
value of waiting, Great Moderation