Working Papers

August 2006, No. 06-6

Understanding How Employment Responds to Productivity Shocks in a Model with Inventories

Yongsung Chang, Andreas Hornstein and Pierre-Daniel G. Sarte

(WP 06-6 replaces earlier versions listed as WP 04-9, WP 01-6, and WP 98-8)

Whether technological progress raises or lowers aggregate employment in the short run has been the subject of much debate in recent years. Using a simple model of industry employment, we show that cross-industry differences of inventory holding costs, demand elasticities, and price rigidities potentially all affect employment decisions in the face of productivity shocks. In particular, the employment response to a permanent productivity shock is more likely to be positive the less costly it is to hold inventories, the more elastic industry demand is, and the more flexible prices are. Using data on 458 4-digit U.S. manufacturing industries over the period 1958-1996, we find statistically significant effects of variations in inventory holdings and demand elasticities on short-run employment responses, but find less evidence pertaining to the effects of measured price stickiness.

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