The Allocation of Non-Leisure Time and the Price of Capital: A Model Applied Empirically to the Wage Curve

Abstract

Our aim in this paper is, first, to derive a model capable of explaining the stylized fact that fluctuations in labor market activities over the business cycle are primarily accommodated by changes in employment rather than in wages and, secondly, to test this model empirically. The model is simple, analytically tractable, capable of explaining a wide range of labor market behavior and, crucially, capable of explaining away real wage rigidities without resorting to market imperfections. Second, when tested empirically, the model is found to be strongly supported by the data of a diverse spectrum of economies. As it turns out, our model shares a key property with Phelps (1994) and Phelps and Zoega (1998), namely, that variations in the price of assets play a pivotal role in explaining variations in employment and in wage rates.