A time-varying finance-led model for U.S. business cycles

Abstract

This paper empirically assesses predictions of Goodwin's model of cyclical growth regarding demand and distributive regimes when integrating the real and financial sectors. In addition, it evaluates how financial and employment shocks affect the labor market and monetary policy variables over six different U.S. business-cycle peaks. It identifies a parsimonious Time-Varying Vector Autoregressive model with Stochastic Volatility (TVP-VAR-SV) with the labor share of income, the employment rate, residential investment, and the interest rate spread as endogenous variables. Using Bayesian inference methods, key results suggest (i) a combination of profit-led demand and profit-squeeze distribution; (ii) weakening of these regimes during the Great Moderation; and (iii) significant connections between the standard Goodwinian variables and residential investment as well as term spreads. Findings presented here broadly conform to the transition to increasingly deregulated financial and labor markets initiated in the 1980s.