The unemployment rate in the second quarter of this year is on track to average 3⁄4 percentage point less than what the staff had anticipated in the September 2012 Tealbook. (Compare the black and red lines in the top left panel of figure 1.) Given the absence of any material change in our assumptions for the natural rate of unemployment as of the April Tealbook, the surprise in the unemployment rate has translated into a roughly equivalent reduction in the gap between the actual and natural unemployment rates (the blue and red lines in the upper right panel of figure 1), with attendant implications for monetary policy.

We construct new estimates of potential output and the output gap using a multivariate approach that allows for an explicit role for measurement errors in the decomposition of real output. Because we include data on hours, output, employment, and the labor force, we are able to decompose our estimate of potential output into separate trends in labor productivity, labor-force participation, weekly hours, and the NAIRU. We find that labor-market variables—especially the unemployment rate—are the most informative individual indicators of the state of the business cycle. Conditional on including these measures, inflation is also very informative. Among measures of output, we find that although they add little to the identification for the cycle, the income-side measures of output are about as informative as the traditional product-side measures about the level of structural productivity and potential output. We also find that the output gap resulting from the recent financial crisis was very large, reaching -7 percent of output in the second half of 2009.

Observers of Silicon Valley's computer cluster report that employees move rapidly between competing firms, but evidence supporting this claim is scarce. Job-hopping is important in computer clusters because it facilitates the reallocation of talent and resources toward firms with superior innovations. Using new data on labor mobility, we find higher rates of job-hopping for college-educated men in Silicon Valley's computer industry than in computer clusters located out of the state. Mobility rates in other California computer clusters are similar to Silicon Valley's, suggesting some role for features of California law that make noncompete agreements unenforceable. Consistent with our model of innovation, mobility rates outside computer industries are no higher in California than elsewhere.

Despite the importance of employer-to-employer (EE) flows to our understanding of labor market and business cycle dynamics, the literature has lacked a comprehensive and representative measure of the size and character of these flows. To construct the first reliable measures of EE flows for the United States, this paper exploits the "dependent interviewing" techniques introduced in the Current Population Survey in 1994. The paper concludes that EE flows are large: On average 2.6 percent of employed persons change employers each month, a flow more than twice as large as that from employment to unemployment. Indeed, on-the-job search appears to be an important element in hiring, as nearly two-fifths of new jobs started between 1994 and 2003 represented employer changes. EE flows are also markedly procyclical, although the cyclicality is concentrated around the recession: EE flows did not increase as the labor market tightened between 1994 and 2000, but they did drop sharply as the labor market loosened during the period 2001 through 2003. We view the uneven cyclical pattern of EE flows as a pattern to be incorporated into future models.

The recent U.S. expansion has provided employment experience to individuals at tail of the skill distribution. Will these opportunities bestow persistent benefits in the form of greater future employability? Using synthetic cohorts constructed from the CPS, this paper estimates the degree of persistence in cohort-level employment rates in excess of persistence in aggregate macroeconomic conditions. This approach is in some ways superior to testing for hysteresis in the aggregate unemployment rate because it abstracts away from compositional changes in the labor force by focusing on particular demographic groups. After controlling for aggregate conditions, there is little evidence of significant persistence in cohorts' employment rates; the effects of aggregate shocks are essentially dissipated within three years. However, economic conditions that prevailed when the cohorts first entered the labor market significantly affect the average lifetime employment rate of cohorts of less-educated men.

A model's ability to explain procyclical movements in real wages has become an important benchmark by which macroeconomists judge business cycle theories. Because Keynesian models with sticky nominal wages predict countercyclical real wages, they have been criticized and dismissed in favor of Real Business Cycle models or New Keynesian models based on price stickiness or countercyclical markups. The bulk of the evidence for procyclical real wages, however, comes from studies using panel data that estimate the unconditional, contemporaneous correlation between real wages and the unemployment rate. These studies constrain real wage cyclicality to be the same irrespective of the source of the business cycle fluctuations. This paper relaxes this constraint and estimates a structural VAR identified by long-run restrictions on the responses of hours and output to labor supply, technology, oil price, and aggregate demand shocks. It finds that real wages are procyclical in response to technology shocks and oil price shocks, but are countercyclical in response to labor supply shocks and aggregate demand shocks. The procyclicality of real wages during the periods covered by the panel data sets may be explained by the importance of the productivity slowdown and the 1970s oil price shocks. The results highlight the limitations of using the unconditional, contemporaneous correlation between real wages and business cycle indicators to sort out competing theories of the business cycle, and cast strong doubt on the appropriateness of the rejection of sticky wage models.

A feature of GMM estimation--the use of a consistent estimate of the optimal weighting matrix rather than the joint estimation of the model parameters and the weighting matrix--can lead to the sensitivity of GMM estimation to the choice of parameter normalization. In many applications, including Euler equation estimation, a model parameter multiplies the equation error in some, but not all, normalizations. But, conventional GMM estimators that either hold the estimate of the weighting matrix fixed or allow some limited iteration on the weighting matrix fail to account for the dependence of the weighting matrix on the parameter vector implied by the multiplication of the error by the parameter. In finite samples, GMM effectively minimizes the square of the parameter times the objective function that obtains from an alternative normalization where no parameter multiplies the equation error, resulting in estimates that are smaller (in absolute value) than those from the alternative normalization. Of course, normalization is irrelevant asymptotically.

This paper models a firm's choice of employment adjustment costs as one component of its choice of production process. In making a one-time choice of production process, firms tradeoff increased flexibility--the reduced cost of changing levels of production--against the diminished efficiency of producing a given level of output. The model predicts that firms facing greater volatility in expected employment choose production processes that entail relatively low costs of adjusting employment. Using estimates of adjustment costs and employment volatility for four-digit manufacturing industries, the paper finds empirical support for the model: Among four-digit industries facing similar choices of production process, those with more volatile employment tend to have lower costs of adjusting employment. Moreover, the paper finds that interindustry heterogeneity in the amplitude of deterministic seasonal fluctuations in employment is more important than the variance of stochastic employment fluctuations in explaining the choice of adjustment costs.