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Capital-labor substitution, equilibrium indeterminacy, and the cyclical behavior of labor income

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  • Jang-Ting Guo
  • Kevin J. Lansing
Abstract
This paper examines the quantitative relationship between the elasticity of capital-labor substitution and the conditions needed for equilibrium indeterminacy (and belief-driven fluctuations) in a one-sector neoclassical growth model. Our analysis employs a ?normalized? version of the CES production function so that all steady-state allocations and factor income shares are held constant as the elasticity of substitution is varied. We demonstrate numerically that higher elasticities cause the threshold degree of increasing returns for indeterminacy to decline monotonically, albeit very gradually. When the elasticity of substitution is unity (the Cobb-Douglas case), our model requires increasing returns to scale of around 1.08 for indeterminacy. When the elasticity of substitution is raised to 5, which far exceeds any empirical estimate, the threshold degree of increasing returns reduces to around 1.05. We also demonstrate analytically that labor?s share of income becomes procyclical as the elasticity of substitution increases above unity, whereas labor?s share in postwar U.S. data is countercyclical. This observation, together with other empirical evidence, indicates that the elasticity of capital-labor substitution in the U.S. economy is actually below unity.

Suggested Citation

  • Jang-Ting Guo & Kevin J. Lansing, 2008. "Capital-labor substitution, equilibrium indeterminacy, and the cyclical behavior of labor income," Working Paper Series 2008-06, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:2008-06
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    References listed on IDEAS

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    Cited by:

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    More about this item

    Keywords

    Capital; Labor supply;

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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