Abstract

We propose a new VAR identification scheme that enables us to disentangle labour supply shocks from wage bargaining shocks. identification is achieved by imposing robust signrestrictions that are derived from a New Keynesian model with endogenous labor force participation. According to our analysis on US data over the period 1985-2014, labour supply shocks and wage bargaining shocks are important drivers of output and unemployment both in the short run and in the long run. These results suggest that identification strategies used in estimated New Keynesian models to disentangle labour market shocks may be misguided. We also analyse the behaviour of the labour force participation rate through the lenses of our model. We find that labour supply shocks are the main drivers of the participation rate and account for about half of its decline in the aftermath of the Great Recession.