The Changing Cyclical Variability of Economic Activity in the United States: A Sectoral Investigation

MAGDA KANDIL Southern Illinois University

Carbondale, lllinois

The Changing Cydica~ Variability of Economic Activity in the United States: A Sectoral Investigation *

Comparing the behavior of sectoral real output in the pre- and postwar periods of United States history is consistent with a larger response of this output to demand shocks for sectors that are subject to a higher degree of nominal wage rigidity in the postwar period. Contrary to the implications suggested by this evidence, sectoral and, in turn, aggregate output are more stable in the postwar period. This investigation suggests that the reduction in the variability of demand shocks and changes in sectoral shares of real GNP are the primary factors underlying the increased stability of the postwar economy.

1. Introduction Changes that have occurred in the cyclical behavior of United

States aggregate economic activity over the past century have been the subject of a number of recent investigations.’ Attention has fo- cused on contrasting the behavior of aggregate macroeconomic time series over the pre- and postwar periods of United States history. While the bulk of the evidence using traditional prewar data sup- ports the views of the increased stability of the postwar economy, the stylized fact of the postwar stabilization has been disputed in a series of papers by Romer. Romer’s work argues that the volatility of traditional output measures after 1947 is little different than before 1929 when revised data measures are used.

Stimulated by the challenge of Romer’s work, Balke and Gor- don (1989) develop new estimates of real GNP, nominal GNP and the GNP deflator for the period 1869-1928. Their paper reaffirms the standard conclusion that real GNP was more volatile before 1929

*I have benefited greatly from valuable discussions with Jo Anna Gray and David Spencer. I also thank anonymous referees for helpful comments on earlier drafts of this paper. All remaining errors are mine.

‘Examples of these studies include Balke and Gordon (1989). DeLong and Sum- mers (1986a,1986b), Kandil (1989), King (1988), Romer (1986a, 1986b,1989), Taylor (1986), and Weir (1985).

Journal of Macroeconomics, Winter 1991, Vol. 13, No. 1, pp. 25-45 25 Copyright 0 1991 by Louisiana State University Press 0164-0794/91/$1.50

Magda Kandil

than since 1946. However, they show that, based on their estimates, there has been no reduction in price flexibility in postwar business cycles. Thus, they suggest that the debate between Taylor (1986) and DeLong and Summers (1986b) on whether greater price stability in the postwar economy has aggravated or dampened business cycles is based on a false premise. They establish, therefore, as a top priority of future research the reexamination of the short- run cyclical division of nominal GNP changes between price and quantity responses in the pre- and postwar periods.

This paper pursues the reexamination issue suggested by Balke and Gordon. I compare the division of nominal GNP changes between inflation and quantity changes in the pre- and postwar periods using new data sources suggested by Balke and Gordon for aggregate and sectoral real output and prices in the prewar period. My results indicate that sectors which are subject to a higher degree of nominal wage rigidity in the postwar period are characterized with a higher response of real output to demand shocks compared to its counterpart in the prewar period. In addition, the price of output for these sectors is characterized with a higher degree of rigidity in the postwar period relative to the prewar period. In turn, aggregate real output is more responsive to demand shocks and the price level is less flexible in the postwar period compared to the prewar period.

Finally, I use my evidence concerning differences in the cyclical behavior of the aggregate and sectoral output in the pre- and postwar periods to examine factors distinguishing the variability of real GNP in the two periods. My results are consistent with my earlier findings, Kandil (1989), that the reduction in the variability of demand shocks in the postwar period has played an important role in determining the increased stability of sectoral and, in turn, aggregate output in the postwar period. The reduction in the variability of these shocks has increased agents’ incentives to write longer contracts. However, smaller demand shocks have a direct stabilizing impact on real activity that has dominated the destabilizing impact associated with the increased rigidity. Further, changes in sectoral shares of real GNP between the pre- and postwar periods have contributed positively to the increased stability of aggregate output in the postwar period. That is because the stable components of GNP have grown relative to the unstable ones. In particular, government, which is a-cyclic, has grown greatly in importance over the last century. In addition, agriculture, which is notoriously unstable, has shrunk rapidly as a share of GNP.

26

The Changing Cyclical Variability of Economic Activity

2. Empirical Strategy My empirical investigation focuses on two periods of United

States history: the prewar period, 1899-1929,2 and the postwar period, 1948-1986.3 I summarize in Tables 1 and 2 selected information on sectors for which real output data exist in the pre- and postwar periods, commodity, construction, transportation-communication, and a residual component.4 I report sector-al shares of total

TABLE 1. Selected Information on Individual Sectors of the U.S. Economw 1899-1929

Union Share of Membership

Share of Sector as a Sector Employment Fraction of

Output in in Total Sector Sector Total Output Employment Employment

Commodity 0.43 0.39 0.091 Construction 0.106 0.055 0.64 Transportation-

Communication 0.081 0.14 0.23 Residual 0.38 0.38 0.053

‘This interval excludes the great depression and World War II and captures two major events: World-War I and the 1920-21 depression. I exclude World War II following the convention established by earlier investigations on the subject. The exclusion of the Great Depression period is motivated by Romer’s (1986a) claim regarding the effect of including this period in raising the sharp contrast in the cyclical variability between the pre- and postwar periods. Experiments in which I include the Great Depression period in the prewar sample period produced results that are similar qualitatively to the ones reported here for the sample period 1899- 1929. These results are available upon request.

3Because of the lags involved in the empirical model, this interval effectively excludes the Korean War.

%ommodity output is synonymous with the sum of value added in the agriculture, mining and manufacturing sectors. Real GNP from Transportation and Communications is the sum of Transportation output and the Telephone and Tele- graph output. Construction output consists of the output of construction materials plus construction value added. The residual component is measured as the difference between the sum of real output generated in these sectors and real GNP as measured by Balke and Gordon for the prewar period and the Commerce De- partment for the postwar period. Accordingly, the residual component captures the sum of value added in the services, finance, trade and government sectors, in each period. Descriptions of the various series used in the investigation are provided in Balke and Gordon (1989).

27

Magdu Kandil

TABLE 2. Selected Znformation on Zndividual Sectors of the U.S. Economy: 1948-1986

Union Share of Membership

Share of Sector as a Sector Employment Fraction of

Output in in Total Sector Sector Total Output Employment Employment

Commodity 0.30 0.31 0.26 Construction 0.12 0.049 0.23 Transportation-

Communication 0.661 0.055 0.39 Residual 0.51 0.59 0.073

NOTES: Sectoral share of total output is the average of the ratio of real output generated in the sector to real GNP over the prewar period 1899-1929 and the postwar period 1948-1986. Sectoral share of total employment is the average of the ratio of sectoral employment to total employment over the prewar period l&9- 1929 and the postwar period 1948-1986. Percent unionized by industry is from Troy and Sheflin (1985). The percentages reported are for 1939 in the prewar period and 1984 in the postwar period. Because of rounding, sum of individual items may not equal one.

output and employment. In addition, I report the ratio of union membership to sectoral employment in the pre- and postwar periods. I use this ratio as an index (albeit an imperfect one) of the importance of contractual wage agreements (both in the explicit and implicit sense) across sectors of the economy in the pre- and postwar periods. ’

The information reported in Tables 1 and 2 indicates that the shares of each of the construction and the transportation-commu-

?he use of this index was first suggested in the context of the investigation by Gray, Kandil, and Spencer (1989). In that investigation, we use this index to de- compose the postwar economy into contract and non-contract sectors. As noted there, this index is considered to be imperfect for two reasons: (i) first, it captures only labor union contracts while my concern is nominal wage rigidity resulting from explicit or implicit contractual agreements, and (ii) second, union membership in- cludes retired and unemployed workers as well as members located in foreign coun- tries. In view of data limitations for the prewar period, I was not able to investigate alternative ways of assessing the importance of wage contracts across sectors of the economy in this period. However, investigating alternative ways in the postwar period resulted in the same designation of sectors as contract and non-contract. Therefore, I use the index reported in Tables 1 and 2 to facilitate comparison between the two periods.

28


nication sectors of real GNP exhibit small changes between the pre- and postwar periods. However, there is a large reduction in the share of the commodity sector of real GNP in the postwar period. This reduction is offset by a rise in the share of the residual component of real GNP in the postwar period. In view of the sugges- tions made by earlier researchers on the subject, one can further speculate that these large differences are attributed to the reduction in the share of agriculture output of real GNP and the growth in the shares of each of the government and service sectors of real GNP over the last century.‘j Sectoral shares of total employment are also consistent with the above observations: While the share of the commodity sector of total employment decreased in the postwar period, the share of the residual component increased. However, there is a large reduction in the share of the communication-transportation sector of total employment.7

On the other hand, the data provided in Tables 1 and 2 concerning the share of union membership of sectoral employment in the pre- and postwar periods suggest the following: contractual wage rigidity plays a relatively more important role in the postwar period. The increased importance is, however, more pronounced in the commodity and the transportation-communcation sectors of the postwar period compared to their counterparts in the prewar period.

Having reviewed the above information, I proceed with the empirical investigation according to the following plan: (i) First, I examine the short-run cyclical division of nominal GNP changes between quantity and price responses using sectoral real output and

61n the 1949 NBER conference, Kuznets refers to the neat coincidence of the simultaneous rise of a-cyclic services and decline of cyclic agriculture. Further, tieLong and Summers (lQ86a) investigate differences in the decomposition of real GNP between the pre- and postwar periods. They use data on the proportion of agricultural commodity production in total commodity production to suggest that there is a sharp decline in the share of the agriculture sector of real GNP in the postwar period. They also suggest, using data on government expenditures, that the share of government purchases of GNP rose from 5% in 190 to 15% of GNP today.

‘Comparing the small reduction in the share of the communication-transportation output of real GNP in the postwar period to the large reduction in its share of total employment in this period suggests that there has been an increase in the elasticity of this sector’s output with respect to the labor input in the postwar period. For other sectors, however, I expect that this elasticity is fairly stable between the pre- and postwar periods in view of the fact that the change in their shares of real GNP and aggregate employment between the two periods is similar.

29

Magda Kandil

price data in the pre- and postwar periods, and (ii) second, I investigate factors distinguishing the variability of real GNP in the pre- and postwar periods. For this investigation, I follow a methodology that accounts for differences in the composition of GNP as well as the variability of its components between the pre- and postwar periods.

3. Empirical Models For the purpose of the empirical investigation, I use the fol-

lowing empirical models:

Dy, = a0 + alDsig, + a2DE,-19, + a3Dy,-l

+ a4Dns, + a,Dqs, + qyt. 0)

Dp, = b, + b,Dsig, + b,DE,-,9, + bsDEteIn,

+ b4Dns, + bgD9s, + qpt. (2)

Here, D(.) is the first-difference operator. The log of real output is denoted by yt and the log of the price level is denoted by p,. The variable sig, is a proxy for sector-specific disturbances that is constructed following Lilien (1982) and Gray and Spencer (forthcoming). I approximate supply-side shifts by anticipated changes in the real energy price, E,-19,, and unanticipated changes in this price, 9s,. In addition, I approximate demand-side shifts by anticipated changes in nominal GNP, EteIn,, and unanticipated changes in this variable, ns,. The terms qyt and qpt are unexplained disturbances with means zero and constant variances.

The above empirical models approximate the solutions for real output and the price level in standard contracting models of the variety of Fischer (1977) and Gray (1978). In these models, real output does not respond to anticipated demand shifts whereas the full equilibrium value of the price level does with the size of the response equal to one. Thus, I expect the magnitude of the param- eter b, to equal one in the absence of any contractual wage rigidity. In addition, theory predicts that anticipated energy price shifts will have a negative impact on the full-equilibrium component of real output and a positive impact on the full-equilibrium component of the price level. Therefore, a2 is expected to be negative and b, is expected to be positive. Further, a rise in the size of sector-specific

30


disturbances is expected to increase “frictional” unemployment, thereby decreasing the natural rate of output and increasing the full-equilibrium value of the price level. Therefore, I expect a, to be negative and b, to be positive. On the other hand, the response of real output and the price level to demand shocks is dependent on the degree of contractual wage rigidity. The increased rigidity of the nominal wage renders the aggregate supply curve flatter which increases the response of real output to demand shocks, ad, and decreases the response of the price level to these shocks, b,. Fur- ther, the increase in contract length will increase the duration of cyclical movements in output and, in turn, the degree of persistence characterizing its movement, that is, a larger a3 is expected. Finally, unanticipated energy price shifts are expected to have a negative impact on real output and a positive impact on the price level. Therefore, a5 is expected to be negative and b, is expected to be positive.

I proceed to estimate the empirical models for real output and the price level together with the equations that generate my empirical proxies for sector-specific disturbances and agents’ forecasts of the real energy price and nominal GNP jointly using nonlinear 3SLS.”

4. Empirical Findings I estimate the empirical models for real output and the price

level using sectoral real output and price data in the prewar period (1899-1929) and the postwar period (1948-1986). In addition, I con- struct indices for aggregate real output and the price level in the pre- and postwar periods as geometric averages of sectoral data with weights that are equal to sectoral shares of aggregate output in each period. In Tables 3 and 4, I summarize the results of estimating sectoral real output as well as my indices for aggregate output in the pre- and postwar periods. According to these results, a share that ranges between 50% and 60% of nominal GNP changes in the prewar period is absorbed in the quantity response of real GNP. In the postwar period, the response of real GNP to demand shocks is much larger compared to its counterpart in the prewar period

‘1 follow the empirical methodology outlined in Gray and Spencer (forthcoming) in deciding on the appropriate representations of the equations that I use to form my empirical proxies. Details of these equations are available from the author upon request.

31

TABL

E 3.

N

on-L

inea

r 3S

LS f

or

Rea

l O

utpu

t in

th

e Pr

ewar

Pe

riod

1899

-192

9

Varia

ble

Mod

el

a,

sig,

Et

- 1q

t Yt

-1

nst

vi P

Y

SS

E

Geo

met

ric

Aver

age

of

Sect

oral

O

utpu

t

Com

mod

ity

Out

put

Con

stru

ctio

n O

utpu

t

Tran

spor

tatio

n-

Com

mun

icat

ion

outp

ut

Res

idua

l O

utpu

t

0)

(2) (1)

(2) (1)

(-59

(1)

(2) (1)

c-3

-0.0

15

(-0.7

1)

0.01

3 (0

.81)

-0.0

11

(-0.5

3)

0.01

2 (0

.73)

0.02

8 (0

.91)

0.

0086

(0

.21)

0.00

32

(0.1

5)

-0.0

0034

(-0

.02)

-0.0

29

(-1.0

6)

0.00

80

(0.4

0)

0.23

-0

.27

(0.4

9)

(-1.5

6)

-2.0

63

-0.8

6 (-1

.90)

(-1

.86)

-0.5

2 0.

048

(-1.0

4)

(0.2

9)

1.13

0.

10

(1.0

3)

(0.5

8)

-0.0

83

(-0.6

3)

0.01

8 (0

.41)

-0

.004

2 (-0

.11)

0.05

7 (0

.29)

-0

.019

(-0

.08)

-0.2

1 (0

.78)

-0

.22

(-0.7

8)

0.23

(1

.26)

0.

35

(1.9

5)

0.34

(1

.71)

0.

10

(0.4

4)

0.61

(4

.86)

0.

49

(6.1

7)

0.46

(3

.33)

0.

40

(3.9

3)

0.93

(3

.38)

0.

77

(3.1

8)

0.47

(3

.45)

0.

69

(8.0

7)

0.88

(4

.66)

0.

53

(4.1

0)

-0.0

68

(-0.9

3)

-0.0

83

(-0.9

6)

-0.4

6 (-2

.38)

0.11

(1

.33)

-0.1

7 (-1

.32)

-0.4

9 (-1

.78)

-0

.39

(-1.4

7)

-0.1

5 (-0

.48)

-0

.074

(-0

.23)

0.18

(0

.53)

0.

26

(0.8

0)

(-0.2

6)

(-0.5

6)

-0.2

1 (0

.55)

-0.4

0 (-1

.80)

-0

.49

(-1.8

9)

0.01

6

0.02

1

0.02

7

0.03

8

0.30

0.33

0.01

7

0.01

6

0.05

0

0.06

5

NOTE

S:

Mode

l’s

equa

tion:

Dy,

= a,

+ a,D

sig,

+ aZ

DE,+

,q,

+ a3

Dy,-l

+ ap

Dns,

+ qD

qs,

+ Q,

Numb

ers

in pa

renth

eses

ar

e t-r

atios

. Th

e err

or ter

m,

r(,,

follow

s an

au

toreg

ress

ive

proce

ss

of or

der

one:

pv

is the

es

timate

of

the

first-o

rder

seria

l co

rrelat

ion

para

meter

. SS

E is

the

regr

essio

n su

m of

squa

red

resid

uals.

TABL

E 4.

N

on-L

inea

r 3S

LS

for

Rea

l O

utpu

t in

th

e Po

stw

ar

Perio

d

Varia

ble

Mod

el

a0

&

Et-1

9,

Yt-1

ns

t 9%

P”

S

SE

Geo

met

ric

Aver

age

of

Sect

oral

O

utpu

t

Com

mod

ity

Out

put

Con

stru

ctio

n O

utpu

t

Tran

spor

tatio

n-

Com

mun

icat

ion

outp

ut

Res

idua

l O

utpu

t

0)

(2)

(1)

(2) (1)

(2)

(1)

(2) (1)

(2)

0.01

0 (2

.53)

0.

012

(2.3

2)

0.01

3 (2

.44)

0.

016

(2.7

7)

0.02

5 (3

.22)

0.

026

(2.0

3)

0.01

3 (3

.68)

0.

020

(4.4

6)

0.02

0 (1

.40)

0.

026

(0.4

9)

-0.5

7 (-

3.05

)

-1.7

3 (-

4.11

)

-1.3

9 (-

2.14

)

-0.7

2 (-

1.99

)

-0.1

5 (-

0.59

)

-0.0

54

(-2.

13)

-0.0

55

(-1.

05)

-0.2

9 (-

3.28

)

-0.4

1 (-

1.09

)

-0.0

50

(-0.

51)

0.67

(5

.40)

0.

65

(4.3

1)

0.50

(3

.22)

0.

48

(2.9

0)

0.74

(1

0.69

) 0.

68

(6.9

8)

1.38

(7

.25)

0.

99

(5.7

9)

0.09

4 1.

11

(0.5

7)

(4.1

2)

0.09

3 0.

84

(0.3

5)

(3.6

2)

(:::) 0.38

(3

.31)

0.

40

(0.9

4)

0.20

(0

.12)

1.23

(9

.20)

0.

89

(7.3

1)

0.21

(2

.04)

0.

043

(0.5

1)

-0.0

84

(-4.

23)

-0.0

70

(-1.

46)

-0.1

8 (-

2.70

)

-0.0

64

(-1.

39)

-0.0

36

(-1.

27)

0.00

49

(0.0

2)

0.01

7 (0

.07)

-0

.038

(-

0.12

) -0

.21

(-0.

93)

-0.0

30

(-0.

11)

0.27

(0

.81)

-0

.56

(-2.

83)

-0.3

4 (-

1.76

) 0.

059

(0.1

2)

0.11

(0

.07)

0.00

15

0.00

51

0.00

86

0.02

2

0.01

6

0.07

0

0.00

78

0.01

6

0.00

42

0.00

53

NOTE

S:

Mode

l’s

equa

tion:

Dy,

= a,

+ a,D

sig,

+ a,D

E,-,q

, +

a3Dy

,-,

+ a,D

ns,

+ as

Dqs,

+ qI,

,

Numb

ers

in pa

renth

eses

ar

e t-r

atios

. Th

e err

or ter

m,

qlyt,

follow

s an

au

toreg

ress

ive

proce

ss

of or

der

one:

pu i

s the

es

timate

of

the

first-o

rder

seria

l co

rrelat

ion

para

meter

. SS

E is

the

regr

essio

n su

m of

squa

red

resid

uals.

Magdu Kandil

with a difference that is statistically significant9 In addition, there is a pronounced difference in the response of real GNP to its lag in the pre- and postwar periods. In the prewar period, this response is small and statistically insignificant. By contrast, this response is large and statistically significant in the postwar period, which is consistent with a higher degree of persistence characterizing movement in real GNP in this period. Further, while anticipated energy price changes and sector-specific disturbances are significant in explaining real GNP in the postwar period, they are insignificant in the prewar period. However, the qualitative differences between the two periods remain robust with respect to a modification in which I suppress these variables from the empirical model, as presented in Model (2) in the tables.

Comparing the results of estimating sectoral real output in the pre- and postwar periods suggests the following: For two sectors, commodity and transportation-communication, the response of real output to demand shocks is much larger in the postwar period compared to the prewar period with a difference that is statistically significant at the 5% level. By contrast, the response of construction output to demand shocks in the postwar period is slightly larger compared to its counterpart in the prewar period, and the difference is insignificant at any reasonable significance level. Further, the output of the residual component reveals a sharp reduction in its response to demand shocks in the postwar period compared to the prewar period.

It is interesting to note that the three sectors (commodity, construction and transportation-communication) comprise all industries identified by Gray, Kandil, and Spencer (1989) as the contract industries of the postwar economy. Indeed, the numbers presented in Table 2 suggest that for these three sectors, the share of union members of sectoral employment constitutes a large share in the postwar period. It appears, therefore, that the sharp increase in the response of the output produced in the commodity and transportation-communication sectors to demand shocks in the postwar period is attributed, at least in part, to the rise in the degree of contractual wage rigidity impinging on these sectors. Similarly, the relatively higher share of union members of total employment in the construction sector of the prewar economy may explain the small difference between the response of its output to demand shocks in

‘For this test, I follow Amemiya’s (1985) suggestion for “A Test of Structural Change When Variances Are Unequal.”

34


the pre- and postwar periods. Further, the relatively less important role played by contractual rigidity in the industries producing the residual output in the postwar period may explain its smaller response to demand shocks compared to other sectors of the economy in this period. However, the relatively larger response of the residual output to demand shocks in the prewar period does not ap- pear to be readily explained by a large share for union members of total employment in this sector. This suggests that other factors must have contributed to the high correlation between this sectoral output and the shocks stemming on the demand-side of the prewar economy. lo

Other differences remain to be noted between the results of estimating sectoral output in the pre- and postwar periods. The response of sectoral output to its lag is consistent with a higher degree of persistence characterizing movements in this output in the postwar period relative to the prewar period: Except for construction output, the coefficient linking sectoral output to its lag is gen- erally large and statistically significant in the postwar period. By contrast, the response of sectoral output to its lag is small and insignificant in the prewar period. In addition, there is a large vari- ation in the role of sector-specific disturbances and energy price shifts in explaining sectoral output in the pre- and postwar periods. However, omitting these variables in Model (2) produced results that are consistent with my observations for Model (1).

In Tables 5 and 6, I summarize the results of estimating the price level in the pre- and postwar periods. According to these results, a share that ranges between 40% and 50% of nominal GNP changes in the prewar period is absorbed in the response of the GNP deflator. This is in contrast to a pronouncedly smaller re-

“‘One of the factors that one may mention in this regard is the change in the decomposition of the residual component of real GNP. The growth of government, which is a-cyclic in nature, may have been an important factor that has contributed to the reduction in the response of the residual component to nominal GNP shocks in the postwar period. Data limitation does not allow the estimation of the residual component without government for the prewar period. However, estimating this component without government in the postwar period resulted in a magnitude of a4 that equals 0.32 with a t ratio that equals 3.18. This moderate improvement in the magnitude and statistical significance of a4 is consistent with my explanation concerning the role that the growth of government may have played in differen- tiating the response of the residual component to demand shocks in the pre- and postwar periods. However, the difference in this response between the two periods remains large. Other factors that my analysis does not address must have contributed to this difference as well.

35

TABL

E 5.

N

on-L

inea

r 3S

LS

for

Sect

or-a

l D

efla

tors

in

th

e Pr

ewar

Pe

riod

Varia

ble

Mod

el

bo

sit3

Et

-a

Et-+

, ns

t w

P

P

SS

E

Geo

met

ric

Aver

age

of

Sect

oral

D

efla

tors

Com

mod

ity

Def

lato

r

Con

stru

ctio

n D

ef l

ater

Tran

spor

tatio

n-

Com

mun

icat

ion

Def

lat

er

Res

idua

l D

efla

tor

0)

(2) (1)

(2)

(1)

(59 (1)

(2)

(1)

(2)

0.01

2 (0

.60)

-0

.013

(-0

.79)

-0.0

13

(-0.7

2)

-0.0

35

(3.3

3)

-0.0

24

(-2.1

5)

-0.0

13

(-0.8

1)

-0.0

18

(-2.1

4)

-0.0

19

(-2.2

1)

0.00

14

(0.1

0)

-0.0

13

(-0.6

7)

-0.0

15

(-0.0

3)

0.07

1 (0

.53)

-0.1

5 (-0

.22)

0.

35

(2.0

2)

0.16

0.

10

(0.3

5)

(0.6

7)

0.54

(1

.43)

0.20

(0

.64

0.25

(2

.13)

0.99

(3

3.22

)

(4kZ

)

1.05

2 (8

.65)

1.

055

(8.7

2)

0.83

(7

.43)

0.

95

(8.3

0)

0.79

(9

.02)

0.

89

(8.0

5)

0.84

(7

.00)

1.

028

(7.0

0)

0.41

(3

.13)

0.

51

(6.2

7)

0.81

(4

.14)

1.

024

(7.4

1)

0.42

(3

.83)

0.

49

(5.6

2)

0.53

(6

.05)

0.

68

(7.7

4)

0.49

(4

.74)

0.

50

(6.0

9)

0.06

2 (0

.81)

0.16

(1

.43)

0.03

2 (0

.41)

0.09

0 (1

.43)

0.04

6 (0

.70)

-0.4

9 (-1

.63)

-0

.42

(-1.5

6)

-0.4

9 (-2

.40)

-0

.39

(-2.1

3)

-0:2

6 (-0

.90)

-0

.46

(-1.6

6)

-0.4

7 (-2

.05)

-0

.26

(-1.1

9)

0.06

9 (0

.27)

0.

057

(0.1

9)

0.01

7

0.02

1

0.01

7

0.04

7

0.02

6

0.02

2

0.02

2

0.03

3

0.02

0

0.01

7

NOTE

S:

Mode

l’s

equa

tion:

Dp,

= b,,

+

b,Dsig

, +

b,DE,

-,q,

+ b,D

E,-,n

, +

b,Dns

, +

b,Dqs

, +

qpt

.

Numb

ers

in pa

renth

eses

ar

e t-r

atios

. Th

e err

or ter

m,

qptr

follow

s an

au

toreg

ress

ive

proce

ss

of or

der

one:

pP is

the

es

timate

of

the

first-o

rder

seria

l co

rrelat

ion

para

meter

. SS

E is

the

regr

essio

n su

m of

squa

red

resid

uals.

TABL

E 6.

N

on-L

inea

r 3S

LS f

or

Sect

oral

D

efla

tors

in

th

e Po

stw

ar

Perio

d

Varia

ble

Mod

el

bo

sigt

Et

-s/t

Cln

t ns

t w

t P

P

SS

E

Geo

met

ric

Aver

age

of

Sect

oral

D

efla

tors

Com

mod

ity

Def

lato

r

Con

stru

ctio

n D

ef l

ater

Tran

spor

tatio

n-

Com

mun

icat

ion

Def

lato

r

Res

idua

l D

ef l

ater

(1)

(2) (1)

c-4 (1)

(2) (1)

(2) (1)

(2)

0.02

0 (1

.54)

0.

021

(1.6

2)

-0.0

23

(-0.

63)

-0.0

29

(-1.

07)

-0.0

24

(-1.

23)

-0.0

39

(-2.

11)

0.00

10

(0.0

5)

-0.0

27

(-1.

45)

0.00

71

(0.4

2)

0.00

42

(0.2

2)

0.32

0.

068

(2.2

5)

(2.1

6)

1.23

(1

.18)

0.

049

(0.4

0)

0.62

(2

.71)

0.

11

(2.3

9)

0.03

8 (0

.15)

0.

085

(1.4

9)

0.38

(0

.63)

0.

12

(1.8

4)

0.34

(2

.18)

0.

30

(2.1

3)

0.79

(1

.63)

0.

85

(2.3

7)

0.96

(4

.16)

1.

12

(4.8

4)

0.50

(2

.W

0.59

(2

.75)

0.

57

(2.5

4)

0.11

(1

.54)

0.

14

(1.6

3)

0.27

(0

.63)

0.

36

(1.3

4)

0.35

(3

.26)

0.

59

(4.1

9)

0.03

2 (0

.29)

0.

19

(1.4

7)

0.56

(2

.66)

0.

67

(3.2

3)

0.06

9 (2

.95)

0.21

(1

.74)

0.11

(3

.35)

0.05

8 (1

.51)

-0.0

24

(-0.

36)

0.71

(5

.55)

0.

72

(6.6

2)

-0.1

9 (-

0.84

) -0

.30

(-1.

56)

0.65

(3

.39)

0.

51

(3.1

8)

(g: ii)

0.

47

(2.5

2)

-0.2

3 (-

1.12

) 0.

077

(0.3

8)

0.00

35

0.00

55

0.10

0.11

0.00

71

0.07

3

0.00

79

0.01

6

0.02

4

0.00

53

NOTE

S:

Mode

l’s

equa

tion:

np,

= h,

+ b,D

sig,

+ b,D

E,-,q

, +

b,DE,

-,n,

+ b,D

ns,

+ b,D

qs,

+ qp

l.

Numb

ers

in pa

renth

eses

ar

e t-r

atios

. Th

e err

or ter

m,

q,,.

follow

s an

au

toreg

ress

ive

proce

ss

of or

der

one:

p,, i

s the

es

timate

of

the

first-o

rder

seria

l co

rrelat

ion

para

meter

. SS

E is

the

regr

essio

n su

m of

squa

red

resid

uals.

Magda Kandil

sponse of the GNP deflator that ranges between 11% and 15% of nominal GNP changes in the postwar period. In addition, the response of the price level to anticipated nominal GNP changes is slightly less than one in the prewar period; this response is signif- icantly smaller in the postwar period. This difference indicates that it takes the price level a longer time to adjust towards its Ml-equilibrium value in the postwar period. In addition, energy price shifts and sector-specific disturbances play a more important role in determining the price level in the postwar period compared to the prewar period. However, the qualitative differences in the cyclical behavior of the price level in the two periods remain robust when these variables are omitted in model (2) of the tables.

I turn to evaluate differences in the cyclical behavior of the deflators of sectoral output in the pre- and postwar periods. Except for the construction deflator, the response of sector-al deflators to anticipated shifts in nominal GNP is larger in the prewar period compared to the postwar period with a difference that is statistically significant. This is consistent with a slower adjustment of the price level towards its full equilibrium value in the postwar period. The response of sectoral deflators to demand shocks is also pronouncedly larger in the prewar period compared to the postwar period for each of the commodity and transportation-communication deflators. For the remaining two sectors, construction and the residual component, the response of sectoral deflators to demand shocks is similar in the pre- and postwar periods. It is interesting to note, in this context, that this evidence is consistent with the results of estimating sectoral real output in the pre- and postwar periods. Sec- tors for which the response of real output to demand shocks is pronouncedly larger in the postwar period, commodity and transportation-communication sectors, are characterized by a significant reduction in the flexibility of their deflators in the postwar period compared to the prewar period. These results provide further evidence that is consistent with the role contractual rigidity may have played in distinguishing the cyclical behavior of real output and price in the pre- and postwar periods.” Sectors that are

“The results of this section are robust with respect to a number of reasonable changes in the specification of my empirical models. I have explored the conse- quences of (i) fitting alternative forecasting models for nominal GNP and the price of energy; (ii) employing alternative methods of dealing with the non-stationarity of my output and price series; (iii) using alternative sets of instruments; and (iv) using a two-step rather than a joint estimation procedure. In this wide range of empirical models, my conclusions are uniformly supported.

38


subject to a higher degree of contractual rigidity in the postwar period have exhibited a large increase in the response of real output to demand shocks and a large reduction in the flexibility of the price level compared to their counterparts in the prewar period.‘* I turn to investigate the impact of these differences in distinguishing the variability of sectoral and, in turn, aggregate output over time.

5. The increased Stability of Output in the Postwar Period: A Sectoral Investigation

Despite the increase in the response of sectoral real output to demand shocks in the postwar period, this output is more stable compared to its counterpart in the prewar period. This can be explained by the fact that there is a large reduction in the size of demand shocks in the postwar period that is significant at the 5% level: The variability of the first-difference of demand shocks, Dns, is 0.01 in the prewar period as compared to 0.0041 in the postwar period. It appears that this reduction has dominated the larger response of sectoral real output to demand shocks in the postwar period and, in turn, has contributed to the rise in the stability of this output.

“I realize that there are other factors that are ignored by my analysis that may have contributed to the observed differences. For example, the analysis ignores the share of durable goods of the output produced in each sector. I expect that a greater share of durable goods in the output produced increases the response of sectoral output to demand shocks. While this factor may be important in distinguishing the cyclical behavior across sectors of the economy in each period, its importance is expected to be of a lesser value when comparing the cyclical behavior of output for a given sector over time. Another factor that is ignored by the analysis concerns differences in supply-side factors that are not related to differences in contracting behavior. For example, the elasticity of supply w.r.t. labor may be greater for one sector compared to other sectors of the economy. In this case, it is hard to predict the cyclical behavior for sectoral output given the information on contractual rigidity only. Recall, however that with the exception of the transportation-communication sector, sectoral shares of real GNP and aggregate employment in the pre- and postwar periods, as reported in Tables 1 and 2, suggest that differences in the elasticity of sectoral output w.r.t. the labor input are of small magnitude over time. Further, in Kandil (1989), I contrast the behavior of total hours worked in the pre- and postwar periods and obtain results that are consistent with those reported in this paper. This leads to my assertion that, despite the simplifying assumptions underlying my methodolgy, the consistency of the data with the implications of contracting models in explaining differences in the cyclical behavior of sectoral output and price over time is very impressive.

39

Magda Kandil

Understanding factors distinguishing the variability of sectoral output in the pre- and postwar periods is not sufficient, however, to understand the changing variability of aggregate output in the United States over the past century. More precisely, the analysis needs to address the impact of changes in sectoral shares of aggregate output between the pre- and postwar periods. Recall that my index of aggregate output is constructed as a geometric average of sectoral output with weights that are equal to sectoral shares of aggregate output in each period. According to this index, the variability of aggregate output, V(yJ, is

n ”

VYJ = 2 $ v(Yi3 + 2 2 Yi Tjcov(Yit, YjJ* (3) i=l i<j

Here, n is four, the number of sectors comprising the aggregate economy, and vi is sectoral share of aggregate output. The convar- iance between sectoral output is denoted by cov(yit, yj,). I then cal- culate an index of sectoral contribution to the variance of real GNP, Ii, by summing up the weighted variance of sectoral output and its share of the covariance between sectoral output as follows:

n

Ii = YP(Yi3 + x 7i?ljcov(Yit, YjJ* (4) j=l

Note that the sum of sectoral contributions, 2;=, Ii, equals the variability of real GNP in each period. This variability is approximately 71% smaller in the postwar period compared to its counterpart in the prewar period.

To identify sectoral contribution to the increased stability of aggregate output in the postwar period, I present some relevant figures in Table 7. The second column of the table summarizes the change in sectoral shares of real GNP in the postwar period, dri. In addition, I present the change in the variability of sector real output, dVy,, and the change in the index of sectoral contributions to the variance of real GNP, dZi, between the pre- and postwar periods. I also present the ratio of the change in this contribution to the total reduction in the variability of real GNP in the postwar period, dZ,/dV,. I use this ratio as an index of the contribution of sectoral output to the increased stability of real GNP in the postwar period.

The residual component contributes with the largest share to the increased stability of aggregate output in the postwar period. Since the share of the residual output of GNP has actually increased in the postwar period, its contribution to the increased stability of

40

TABL

E 7.

Se

ctor

al

Con

tribu

tion

to

the

Incr

ease

d St

abili

ty

of

Rea

l G

NP

in

the

Post

war

Pe

riod

dh

Sect

or

&i

&Yi

dZ,

dV,

dl”

Com

mod

ity

-0.1

3 -0

.000

6 -0

.000

6 30

.77

-0.0

0032

C

onst

ruct

ion

0.01

4 -0

.017

-0

.000

32

16.4

1 -0

.000

31

Tran

spor

tatio

n-C

omm

unic

atio

n -0

.02

-0.0

023

-0.0

0011

5.

64

-0.0

0007

1

dz””

dVr

19.2

8 18

.68

4.28

R

esid

ual

0.13

-0

.005

0 -0

.ooo

92

47.1

8 -0

.000

96

57.8

5

Tota

l -0

.001

95

-0.0

0166

NOTE

S:

dyi

= yp

”’ -

rl, the

ch

ange

in

secto

ral

share

s of

real

GNP

in the

po

stwar

pe

riod.

dvy,

= Vy

,P”’

- Vy

,p”,

the

chan

ge

in the

va

rianc

e of

secto

ral

real

outpu

t in

the

postw

ar

perio

d. dZ

, =

Zp”’

- Zp

”, the

ch

ange

in

secto

ral

contr

ibutio

n to

the

varia

nce

of re

al GN

P in

the

postw

ar

perio

d. dV

=

VP”’

- V:

” =

Z:=,

dz,,

the

chan

ge

in the

va

rianc

e of

real

GNP

in the

po

stwar

pe

riod.

dZ”

= Zp

asrc4

-

I:“,

the

chan

ge

in se

ctora

l co

ntribu

tioi

to tit

le va

rianc

e of

real

GNP

in the

po

stwar

pe

riod

unde

r the

as

sump

tion

that

dy,

= 0.

dVy

= Vy

*‘-’

- Vr

=

Cf=,

dzy,

the

chan

ge

in the

va

rianc

e of

real

GNP

in the

po

stwar

pe

riod

unde

r the

as

sump

tion

that

dy,

= 0.

Magda Kandil

the postwar economy stems primarily from the reduction in the variability of its output. The smaller variability of the residual output is largely attributed to the reduction in the contribution of demand shocks to the variability of this output in the postwar period. The commodity sector has the second largest contribution to the increased stability of real GNP in the postwar period. This large share stems primarily from a large reduction in the share of this sector’s output of real GNP in the postwar period along with some reduction, although a relatively small one, in the variability of commodity output in the postwar period. Further, the output of the construction and the transportation-communication sectors have relatively small shares of the increased stability of output in the postwar period. Despite the reduction in the variability of the output produced in these two sectors in the postwar period, their relatively small shares of GNP in the pre- and postwar periods have decreased the size of their contributions to the increased stability of the postwar economy.

The evidence of the change in sector-al shares of real GNP between the pre- and postwar periods stimulates interest to deter- mine the impact this change may have had on the increased stability of the postwar economy. To isolate this impact, I recalculate my index of sectoral contributions to the variance of real GNP, Ii, in the postwar period under the assumption of equal sectoral shares of aggregate output in the pre- and postwar periods. That is, I as- sume that sectoral shares of real GNP in the postwar period rep- licate their counterparts in the prewar period. Under this assumption, I recalculate the change in sectoral contributions to the variance of real GNP in the postwar period compared to the prewar period, dZ1”“, and the ratio of this change to the new difference in the variability of aggregate output between the pre- and postwar periods, dZ”/dVlt”“. The results of these recalculations are reported in Ta- ble 7. Comparing 2f=i dZi to Zf=i dZlm, suggests the following.

Changes in sectoral shares of real GNP between the pre- and postwar periods have contributed positively to the improvement in the increased stability of GNP in the postwar period. The numbers presented in Table 7 suggest that approximately 15% of the reduction in the variability of GNP in the postwar period is attributed to changes in the decomposition of GNP in this period compared to the prewar period. According to my analysis, the major factor through which the changing decomposition has contributed with this share to the increased stability of real GNP in the postwar period is the following: The reduction in the share of commodity output

42


for which the variability of output is high was replaced by an increase in the share of the residual output for which the variability of output is considerably smaller.

6. Conclusion This paper utilizes new data sources of aggregate and sectoral

real output and prices in the prewar period to contrast the cyclical behavior of these variables to their counterparts in the postwar period. The estimated models explain cyclical fluctuations in these variables using empirical proxies for aggregate demand shocks and energy price shocks. Energy price shocks are observed to have played a more important role in determining cyclical fluctuations in real output and the price level in the postwar period compared to the prewar period. By contrast, demand shocks are observed to have been an important determinant of movements in real output and the price level across the economy in the pre- and postwar periods. The response of aggregate output to these shocks is, however, larger in the postwar period relative to the prewar period. This appears to be consistent with a significant reduction in the response of the price level to demand shocks in the postwar period. The difference between the pre- and postwar periods is even more pronounced in comparing the response of sectoral output and prices to demand shocks. Sectors that are subject to a high degree of wage rigidity in the postwar period are characterized with a large increase in the response of real output to demand shocks and a large reduction in the response of the price level to these shocks compared to their counterparts in the prewar period. Such evidence is highly consistent with the implications of standard sticky-wage contracting models concerning the role the increased rigidity may have played in dif- ferentiating the cyclical behavior of sectoral and, in turn, aggregate output and price over time.

On the other hand, there is a significant reduction in the variability of demand shocks in the postwar period. The results suggest that this reduction has had a large positive contribution to the increased stability of the postwar economy. Indeed, there is a significant reduction in the variability of sectoral output in the postwar period. The size of sectoral contribution to the increased stability of the postwar economy varies, however, across sectors of the economy. The largest contribution is attributed to the residual component of real GNP, finance, government, trade and service sectors, for which there is a pronounced reduction in the output response

43

Ma&a Kandil

to demand shocks in the postwar period. By contrast, the commodity-producing sector, which has experienced a significant rise in the degree of nominal wage rigidity, is characterized by a pronounced increase in its response to demand shocks in the postwar period. In turn, the reduction in the variability of its output is very moderate compared to other sectors of the economy in this period.

Finally, I consider the impact of changes in sectoral shares of real GNP in distinguishing its variability in the pre- and postwar periods. This investigation suggests that this accounting factor has contributed with approximately 15% of the total reduction in the variability of GNP in the postwar period. That is because the share of the commodity-producing sector for which the variability of output is high was replaced by an increase in the share of the residual component for which the variability of output is considerably smaller. While this result sheds some light on sources of the increased stability of the postwar economy, it stimulates interest for further research. This research should investigate factors distinguishing the variability of the commodity and the residual components of real GNP in the pre- and postwar periods. The speculation made by earlier investigations on the subject suggests that the growth in the share of government together with the decline in the share of agriculture of total output are important factors to consider in this context. These factors should be the focus of a careful empirical investigation, however. Exploring new data sources that would allow further disaggregation of the aggregate output figure in the prewar period should be the starting point for this future research.

Received: May 1989 Final version: May 1990

References Amemiya, Takeshi. Advanced Econometrics. Massachusetts: Har-

vard University Press, 1985. Balke, Nathan S., and Robert J. Gordon. “The Estimation of Pre-

war GNP Volatility, 1869-1938.” Journal of Political Economy 97 (February 1989).

DeLong, J. Bradford, and Lawrence H. Summers. “The Changing Cyclical Variability of Economic Activity in the United States.” In The American Business Cycle: Continuity and Change, edited by Robert J. Gordon, 679-733(a). Chicago: University of Chicago Press for NBER, 1986a.

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-. “Is Increased Price Flexibility Stabilizing?’ The American Economic Review 76 (1986b): 1031-44.

Fischer, Stanley. “Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule.” Journal of Political Economy 85 (1977): 163-190.

Gray, Jo A. “On Indexation and Contract Length.” JournaZ of Po- litical Economy 86, no. 1 (1978): 1-18.

Gray, Jo A., Magda Kandil, and David E. Spencer. “Some Evi- dence on the Role of Contractual Wage Rigidity in Determining Real Activity.” Manuscript, Southern Illinois University, 1989.

Gray, Jo A., and David E. Spencer. “Price Prediction Errors and Real Activity: A Reassessment.” Economic Inquiry (forthcoming).

Kandil, Magda. “Some Evidence on the Role of Demand Fluctua- tions in Determining the Increased Stability of the Post-War Economy.” Manuscript, Southern Illinois University, 1989.

King, Stephen R. “Is Increased Price Flexibility Stabilizing?: Com- ment.” The American Economic Review 78 (1988): 267-72.

Lilien, David M. “Sectoral Shifts and Cyclical Unemployment.” Journal of Political Economy 90 (1982): 777-93.

Romer, Christina D. “Spurious Volatility in Historical Unemploy- ment Data.” Journal of Political Economy 94 (1986a): l-37.

-. “Is the Stabilization of the Postwar Economy a Figment of the Data?’ American Economic Review 76 (1986b): 314-34.

-. “The Prewar Business Cycles Reconsidered: New Estimates of Gross National Product, 1869-1908.” Journal of Political Economy 97 (1989): l-37.

Taylor, John B. “Improvements in Macroeconomic Stability: The Role of Wages and Prices.” In The American Business Cycle: Continuity and Change, edited by Robert J. Gordon, 639-77. Chicago: University of Chicago Press for NBER, 1986.

Troy, Leo, and Neil Sheflin. Union Source Book: Membership, Structure, Finance and Directory. West Orange, N. J.: Industrial Relations Data Information Services, 1985.

Weir, David R. “Stabilization Regained: A Reappraisal of the U.S. Macroeconomic Record, 1890-1980.” Yale University, 1985. Mimeo.

45

Documents

The Changing Cyclical Variability of Economic Activity in the United States: A Sectoral Investigation