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Search Frictions and the Labor Wedge

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Author Info

  • Andrea Pescatori

    ()
    (International Monetary Fund)

  • Murat Tasci

    ()
    (Federal Reserve Bank of Cleveland)

Abstract

This paper assesses whether labor market frictions, in the form of searching and matching, can help explain movements in the labor wedge—the gap between the marginal rate of substitution (MRS) and the marginal productivity of labor in a perfectly competitive business cycle model. Results suggest that those frictions are not able to explain fluctuations in the labor wedge, per se. However, the introduction of extensive and intensive margin shows that measuring the MRS in terms of total hours artificially introduces procyclicality in the MRS. When the MRS is correctly measured in terms of hours per worker, the labor wedge obtained is less variable than the one of the perfectly competitive model. A Frisch elasticity of 2.8, as in most macro models, implies a 20 percent decline in the variability of the labor wedge. A Frisch elasticity closer to micro estimates implies an even higher reduction. Finally, we show that it is possible to measure a strongly procyclical labor wedge as in CKM (2007) even if the actual data generating process does not have any labor wedge but has search frictions that allow for movements in both labor margins.

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Bibliographic Info

Paper provided by Koc University-TUSIAD Economic Research Forum in its series Koç University-TUSIAD Economic Research Forum Working Papers with number 1113.

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Length: 38 pages
Date of creation: May 2011
Date of revision:
Handle: RePEc:koc:wpaper:1113

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Keywords: Labor Market Search; Business Cycle Accounting; Labor Wedge;

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Cited by:
  1. Kenneth Beauchemin & Murat Tasci, 2008. "Diagnosing labor market search models: a multiple-shock approach," Working Paper 0813, Federal Reserve Bank of Cleveland.

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