Countercyclical Elasticity of Substitution

• Authors: Raül Santaeulàlia-Llopis.
• BSE Working Paper: 112146 | January 17
• Keywords: labor market , labor share , capital , short-run , elasticity , substitution , labor , cycle
• JEL codes: E13, E32
• labor market
• labor share
• capital
• short-run
• elasticity
• substitution
• labor
• cycle

We empirically show that the short-run elasticity of substitution between capital and labor (σ_t) is countercyclical. In recessions, capital and labor are more substitutable than in expansions. This countercyclicality of σ_t introduces an asymmetry in an otherwise standard competitive-markets business cycle model that contributes to resolve several labor market puzzles: the labor productivity puzzle, the Dunlop-Tarshis phenomenon, the hours-productivity puzzle, and the labor share puzzle.