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The Consumption-Tightness Puzzle

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  • Morten O. Ravn

Abstract

This paper introduces a labor force participation choice into a labor market matching model embedded in a dynamic stochastic general equilibrium set-up with production and savings. The participation choice is modelled as a tradeoff between forgoing the expected benefits of being search active and engaging in costly labor market search. The model induces a symmetry in firms’ and workers’ search decision since both sides of the labor market vary search effort at the extensive margins. We show that this set-up is of considerable analytical convenience and that it gives rise to a linear relationship between labor market tightness and the marginal utility of consumption. We refer to the latter as the “consumption - tightness puzzle” because (a) it gives rise to a number of counterfactual implications, and (b) it is a robust implication of theory. Amongst the counterfactual implications are very low volatility of tightness, procyclical unemployment, and a positively sloped Beveridge curve. These implications all derive from procyclical variations in participation rates that follow from allowing for the extensive search margin.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2006/13.

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Date of creation: 2006
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Handle: RePEc:eui:euiwps:eco2006/13

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Keywords: Labor market participation; matching models; intensive search margin; labor market tightness; unemployment; homework.;

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