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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Paper provided by European University Institute in its series Economics Working Papers with number
ECO2006/13.
Length: Date of creation: 2006 Date of revision: Handle: RePEc:eui:euiwps:eco2006/13
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Morten O. Ravn, 2008.
"The Consumption-Tightness Puzzle,"
NBER Chapters,
in: NBER International Seminar on Macroeconomics 2006, pages 9-63
National Bureau of Economic Research, Inc.
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Find related papers by JEL classification: E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles J20 - Labor and Demographic Economics - - Demand and Supply of Labor - - - General J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search
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Mehra, Rajnish & Prescott, Edward C., 2003.
"The equity premium in retrospect,"
Handbook of the Economics of Finance,
in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 14, pages 889-938
Elsevier.
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