Search,shirking and labor market volatility

This paper proposes a modified version of the standard search and matching model of the labour market that includes a shirking mechanism. We show that our model delivers a close match to the simulated volatilities, correlations and autocorrelations of unemployment, vacancies, labour market tightness and the job finding rate with values observed in US data. In doing so, it outperforms prominent alternative models. Our model also has novel policy implications for the impact of income taxes, subsidies on hiring and employment taxes on unemployment and its volatility.     

Creation of jobs and firm-sponsored training in a matching model of unemployment

We offer a search and matching model with firms that create job vacancies and are willing to sponsor general skills training. The spillover of skilled labor between firms has the dual effect of increasing job vacancies and enhancing firms’ incentives for free riding. The former effect is combined with a reduction in search costs to cause a positive feedback between the supply of skilled labor and the creation of job vacancies, suggesting that firms encourage each other. On the other hand, with the latter effect, search costs are reduced, inducing firms to take a free ride on each other’s investments, thereby decreasing the supply of skilled labor and the creation of job vacancies. A reduction in search costs can lead to different results depending on which of the two mechanisms is actualized. Additionally, our analysis allows for “labor poachers,” or firms absorbing skilled labor in the market, to consider direct competition between training firms and poaching firms.      

The importance of firing costs and the Hosios condition in search models with endogenous job destruction

We construct a DSGE search model with endogenous job destruction, incorporating wage rigidities, firing costs and unemployment benefit. We investigate the most important factors in matching the model’s cyclical properties with empirical data, particularly those of job creation rates (JCR) and job destruction rates (JDR). Firing costs assist significantly in explaining the procyclicality of JCR, the negative correlation of JCR and JDR, and the persistence of vacancies. They also decrease the counter-cyclicality of job turnover. We also postulate that the Hosios condition helps explain the negative correlation of JCR and JDR and vacancies’ persistence. Varying wage rigidities and unemployment income, however, do not improve the results.     

Sensitivity of Job Destruction to Vintage and Tenure Effects

Matching models with endogenous job destruction typically deliver excessively volatile job destruction and moderate volatility of vacancies. In our model, vintage and tenure effects promote the creation of new matches that are temporarily more productive, while reducing the survival of temporarily less productive matches. This cleansing effect produces a counter‐cyclical inflow into unemployment, removes the strong response of job destruction to productivity shocks, and generates a downward‐sloping Beveridge curve, as in the data. The model also generates more volatility in vacancies, the job‐finding rate, and labor‐market tightness.     

Worker heterogeneity and labor market volatility in matching models

Shimer demonstrated that aggregate productivity shocks in a standard matching model cause fluctuations in key labor market statistics—such as the job-finding rate, the vacancy/unemployment ratio, and the unemployment rate—that are too small by an order of magnitude [Shimer, R., 2005. The cyclical behavior of equilibrium unemployment and vacancies. American Economic Review 95 (1) 25–49]. This paper shows that when the standard model is extended to allow for worker heterogeneity, it exhibits considerably greater volatility. In the model, marginal workers, whose productivity only slightly exceeds the value of their alternative use of time, constitute a disproportionate share of unemployment on average, and that share rises when aggregate conditions deteriorate. These composition effects cause firms to open fewer vacancies during downturns.     

Fiscal stimuli in the form of job creation subsidies

This paper examines the effects of fiscal stimuli in the form of job creation subsidies in a DSGE model with search friction and endogenous job separation. We consider two types of job creation subsidies: a subsidy for the cost of posting vacancies and a hiring subsidy. This paper finds that the effects of job creation subsides on unemployment differ between models with and without endogenous job separation. While a positive job creation subsidy shock lowers unemployment in a model without endogenous job separation, it increases unemployment in a model with endogenous job separation. We also find that while qualitatively the effects of a vacancy cost subsidy on the economy are similar to those of a hiring subsidy, quantitatively they are different.     

Trade Competitiveness and Employment: Job Creation or Job Destruction

This paper empirically examines the impact of fluctuations in international trade competitiveness on employment in the UK manufacturing sector over the period 1999–2010. We find statistically significant but economically small effects of a shock to international trade competitiveness on the level of employment. Our results show that the adjustment process in employment mainly works through job creation. We also find that compared to large firms, small firms contribute more toward job creation than job destruction. Our results that changes in GDP growth rate and average wages are significantly related to employment suggest that the UK labour market significantly responds to market forces. Finally, we find that the effect of changes in the real exchange rate on both job creation and job destruction differs between exporting and non-exporting firms.     

More on unemployment and vacancy fluctuations

Shimer [Shimer, R., 2005a. The cyclical behavior of equilibrium unemployment and vacancies. American Economic Review 95 (March), 25–49] argues that the textbook equilibrium search model of unemployment explains less than 10% of the volatility in US vacancies and unemployment when fluctuations are driven by productivity shocks. His paper as well as other recent work inspired by it are reviewed and extended here. Although there seems to be excessive feedback from the job-finding rate to the wage built into the Nash bargaining mechanism assumed to determine wages in the model, we argue that he and others overemphasize the need for wage rigidity to explain the data on labor-market fluctuations. Indeed, a modified version of the model can explain the magnitude of the empirical relationship between the vacancy–unemployment ratio and labor productivity when wages are the outcome of a strategic bargaining game and when the elasticity of the matching function and the opportunity cost of a match are set at reasonable values. The modified model also explains almost two thirds of the volatility in the ratio relative to that of productivity when separation shocks are taken into account, as well as the strong negative correlation between vacancies and unemployment found in Shimer's data.     

Vacancies and Unemployment in Australia

This article examines the extent to which the Mortensen–Pissarides model of labour market search can quantitatively match business cycle fluctuations in Australia. With productivity and job‐separation‐rate shocks, the model fails to produce substantial volatility among unemployment or vacancies, a result similar to Shimer's (2005) findings for the United States. Examining a broader range of shocks significantly increases the magnitude of business cycle fluctuations, but still only explains roughly 25 per cent of labour market volatility. The implied volatility of wages in the model is similar to that in the data and hence excessive wage flexibility is unlikely to be central to the failure of the model as claimed in the literature.     

Working capital requirement and the unemployment volatility puzzle

Shimer (2005) argues that a search and matching model of the labor market in which wage is determined by Nash bargaining cannot generate the observed volatility in unemployment and vacancy in response to reasonable labor productivity shocks. This paper examines how incorporating monopolistically competitive firms with a working capital requirement (in which firms borrow funds to pay their wage bills) improves the ability of the search models to match the empirical fluctuations in unemployment and vacancy without resorting to an alternative wage setting mechanism. The monetary authority follows an interest rate rule in the model. A positive labor productivity shock lowers the real marginal cost of production and lowers inflation. In response to the fall in price level, the monetary authority reduces the nominal interest rate. A lower interest rate reduces the cost of financing and partially offsets the increase in labor cost from a higher productivity. A reduced labor cost implies the firms retain a greater portion of the gain from a productivity shock, which gives them a greater incentive to create vacancies. Simulations show that a working capital requirement does indeed improve the ability of the search models to generate fluctuations in key labor market variables to better match the U.S. data.     

Worker flows, job flows and firm wage policies

Like many transition economies, Slovenia is undergoing profound changes in the workings of the labour market with potentially greater flexibility in terms of both wage and employment adjustment. To investigate the impact of these changes, we use unique longitudinal matched employer‐employee data that permits measurement of employment transitions and wages for workers and enables links of the workers to the firms in which they are employed. We can thus measure worker flows and job flows in a comprehensive and integrated manner. We find a high pace of job flows in Slovenia especially for young, small, private and foreign‐owned firms and for young, less educated workers. While job flows have approached the rates observed in developed market economies, the excess of worker flows above job flows is lower than that observed in market economies. A key factor in the patterns of the worker and job flows is the determination of wages in Slovenia. A base wage schedule provides strict guidelines for minimum wages for different skill categories. However, firms are permitted to offer higher wages to an individual based upon the success of the worker and/or the firm. Our analysis shows that firms deviate from the base wage schedule significantly and that the idiosyncratic wage policies of firms are closely related to the observed pattern of worker and job flows at the firm. Firms with more flexible wages (measured as less compression of wages within the firm) have less employment instability and are also able to improve the match quality of their workers. JEL Classifications: J23, J31, J41, J61, P23, P31.     

Estimating matching functions when recruiting intensity matters

The article estimates matching functions – the relationships between new hires, job vacancies and unemployment – using monthly time series data for Sweden. The data contain rich information on types of job vacancies which provides information on firms’ recruiting efforts. The analysis shows that the aggregate flow of new hires is well explained by an augmented version of a standard matching function that incorporates data on firms’ recruiting intensity.     

BUSINESS CYCLES IN THE EQUILIBRIUM MODEL OF LABOR MARKET SEARCH AND SELF‐INSURANCE*

I introduce risk‐aversion, labor‐leisure choice, capital, individual productivity shocks, and market incompleteness to the standard model of labor search and matching and investigate the model’s cyclical properties. I find that the model can generate the observed large volatility of unemployment and vacancies with a reasonable replacement rate of unemployment insurance benefits of 64%. Labor‐leisure choice plays a crucial role through additional utility from leisure when unemployed and further amplification from adjustments of hours worked. On the other hand, the borrowing constraint or individual productivity shocks do not significantly affect the cyclical properties of unemployment and vacancies.     

Rent Rigidity,asymmetric information,and volatility bounds in labor markets

Two thirds of US unemployment volatility is due to fluctuations in workers' job-finding rate. In search and matching models, aggregate productivity shocks generate such fluctuations: via inputs in the matching technology, they affect the rate at which workers and firms come into contact. Quantitatively, this mechanism has been found to be negligible in a calibrated textbook model, but also more than sufficient if wages are completely rigid. We study a weaker concept of rigidity based on worker rents (wages in excess of the value of unemployment). We show that volatility is subject to an upper bound if worker rents are weakly procyclical, thus at best rigid. Quantitatively, with Rent Rigidity, the mechanism accounts for at most 20% of the variance of the job-finding rate. In light of this result we reexamine the question whether asymmetric information on gains from trade amplifies fluctuations. We analyze a series of bargaining solutions, and conclude that asymmetric information at best makes rents rigid. Our analysis provides a unifying perspective on a very lively debate.     

Job Creation, Job Destruction, and the International Division of Labor

The authors incorporate equilibrium unemployment due to imperfect matching into a model of trade in intermediate inputs. Firms are assumed to be price‐takers and their size is given by technology. Firms enter the market as long as expected profits cover the search cost they incur initially; jobs are endogenously destroyed by random shocks that affect firms’ price–cost margins. Trade increases productivity in the final good and then demand for each intermediate input. Steady‐state unemployment is reduced after trade integration because the rate of job destruction is reduced, which in turn induces an indirect positive effect on job creation. A more volatile environment faced by firms does not necessarily increase unemployment. However, the rate of job destruction unambiguously rises, and rises more under free trade.     

Modelling labour market dynamics with on-the-job search

A flow model of the Dutch labour market is used to calculate the effects of policy options which aim to enhance employment, especially at the lower end of the labour market. The model distinguishes between good and bad jobs, allows for endogenous wage formation and job creation, and describes the flows between these jobs so that job-to-job mobility and the vacancy chain is made endogenous. In the matching process employed job seekers with bad jobs compete with short-term and long-term unemployed for the filling of vacancies for good jobs. In each period part of the good and bad jobs are destroyed which results in inflow into unemployment. The model explicitly describes the flow of unemployed through the various duration classes of unemployment and it allows for negative duration dependence so that the escape probability from unemployment for long-term unemployed is smaller than for short-term unemployed. The model is used to simulate the effects of external shocks, such as structural productivity shocks. An impulse response analysis using the model is also conducted considering labour market policies which aims especially to enhance employment at the lower end of the labour market. In particular, the effects are analysed of measures subsidising the opening of bad jobs (jobs at the lower end of the labour market) and a rise in the productivity of a bad job as compared to a good job which can be achieved by changes in the tax system.     

Search, Nash bargaining and rule-of-thumb consumers

This paper analyses the effects of introducing two typical Keynesian features, namely rule-of-thumb (RoT) consumers and consumption habits, into a standard labour market search model. RoT consumers use the margin that hours and wage negotiation provides them to improve their lifetime utility, by narrowing the gap in utility with respect to Ricardian consumers. This margin for intertemporal optimisation has not been studied yet, because this class of restricted agents has been mainly used in models with no equilibrium unemployment. Our approach allows for a deeper study of the effects of shocks on vacancies, unemployment, hours, wages and how they interact. As habits increase, RoT consumers find it optimal, after a positive technology shock, to negotiate lower hours and higher wages, and this mechanism reduces the simulated correlation between the real wage (or productivity) and total hours to values closer to those obtained empirically. Thus, with the interaction of RoT consumers and consumption habits, the labour market search model improves significantly in reproducing some of the stylised facts characterising the US labour market.     

PRECAUTIONARY DEMAND FOR LABOUR AND FIRM SIZE

This paper studies firms' job creation decisions in a labour market with search frictions. A simple labour market search model is developed in which a firm can search for a second employee while producing with a first worker, and this creates the equilibrium size distribution of firms. A firm expands employment even if the instantaneous payoff to a large firm is less than that of staying small – a firm has a precautionary motive to expand its size. In addition, this motive is enhanced by a greater market tightness. Because of this effect, firms’ decisions become interdependent – a firm creates a vacancy if it expects other firms to do the same, creating strategic complementarity among firms and thereby self‐fulfilling multiple equilibria. An increase in productivity can cause a qualitative change in labour market tightness and the rate of unemployment.     

Effect of labor market policies on unemployment when firms adapt their recruitment strategy

Firms conduct interviews to select who to hire. Their recruitment strategies affect not only the hiring rate but also job destruction rate as more interviews increase the chances of finding the right worker for the job; a link mostly overlooked in the literature. I model this recruitment behavior and investigate the effects of labor market policies on unemployment. These policies change the value of hiring the right worker, altering firms' incentives to conduct interviews. Policies further affect job creation and destruction when firms adapt their recruitment strategies. Net effect of a policy on unemployment depends on the magnitude of change in job creation versus destruction. Qualitative analysis reveals that the effect of a policy on unemployment is mostly weakened with the introduction of firms' recruitment behavior to the model. Firing taxes still increase unemployment, albeit at a lower rate. The effect of hiring subsidies on unemployment is even reversed: Unemployment increases with hiring subsidies if firms adapt. Minimum wage and unemployment insurance policies are also analyzed.     

Labor market institutions and aggregate fluctuations in a search and matching model

This paper explores the influence of labor market institutions on aggregate fluctuations. It uses a dynamic, stochastic, general equilibrium model characterized by search and matching frictions in the labor market and nominal rigidities in the goods market. It finds that firing costs and unemployment benefits can have substantial effects on aggregate fluctuations. Increasing firing costs decreases the volatility of output, employment, and job flows due to the reduction in the mass of jobs sensitive to disturbances and lower incentives for firms to hire and fire workers. Hence, firms adjust to shocks mainly through prices, causing inflation to become more volatile. Raising unemployment benefits has the reverse effect on aggregate fluctuations.