The Importance of Proportional and Fixed Hiring Costs in Search and Matching Models

We show that in any reconfigured matching model of the labor market low hiring costs, specifically proportional ones, play a central role in generating large unemployment volatility. Moreover, we show that low proportional hiring costs also play a critical role in inducing wage inertia, and that there is a tight relationship between proportional hiring costs and fundamental surplus fraction. They are two sides of the same coin. We then use unique German data, from which we extract measures of proportional and fixed hiring costs and relate them to output. We find that the ratio of proportional hiring costs to output is very low, while fixed hiring costs are relatively large. Finally, we use our empirical estimates of hiring costs to calibrate the canonical matching model, augmented with fixed hiring costs. We show that for values of the proportional and fixed hiring costs in line with our data the model can generate an empirically relevant market tightness elasticity, given plausible values of other parameters (including the replacement ratio).