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Search Frictions and the Labor Wedge

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  • Murat Tasci

    (Federal REserve Bank of Cleveland)

  • Andrea Pescatori

    (IMF)

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    Abstract

    This paper addresses the question whether search frictions can help us explain some of the movements in the labor wedge. We present a model with labor market frictions -- in the form of search and matching -- that nests the prototype RBC model. Search and matching frictions in our model helps us to meaningfully distinguish between the extensive and the intensive margin. We find that search frictions reduce the optimal decision of hours to a tradeoff between the marginal cost of an additional hour at the intensive margin (i.e. hours of work per employed worker) and the marginal benefit of this additional output. We have a different labor wedge than implied by the prototype RBC model. However, it is not because of the search frictions per se, but because of the distinction between the extensive and the intensive margin. In our model, this amounts to modifying the MRS. It turns out that the modification is in the right direction, that is the labor wedge we obtain is much less variable than the prototype labor wedge and correlated less with the MPL. This result is sensitive to the exact parameterization of the elasticity of labor. We find that, for instance, when Frisch elasticity is relatively high, such as 2.7, as in most macro models, we can get upto 15-20 percent decline in the variability of the measured labor wedge. This result is even stronger for Frisch elasticities that is more consistent with the micro estimates. Moreover, we show that one can easily 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.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 371.

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    Date of creation: 2011
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    Handle: RePEc:red:sed011:371

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    1. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877.
    2. Ours, J.C. van & Ridder, G., 1992. "Vacancies and recruitment of new employees," Open Access publications from Tilburg University urn:nbn:nl:ui:12-142178, Tilburg University.
    3. van Ours, Jan & Ridder, Geert, 1992. "Vacancies and the Recruitment of New Employees," Journal of Labor Economics, University of Chicago Press, vol. 10(2), pages 138-55, April.
    4. David M. Arseneau & Sanjay K. Chugh, 2009. "Tax smoothing in frictional labor markets," International Finance Discussion Papers 965, Board of Governors of the Federal Reserve System (U.S.).
    5. Simona E. Cociuba & Alexander Ueberfeldt, 2010. "Trends in U.S. hours and the labor wedge," Globalization and Monetary Policy Institute Working Paper 53, Federal Reserve Bank of Dallas.
    6. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
    7. Lee Ohanian & Andrea Raffo & Richard Rogerson, 2006. "Long-Term Changes in Labor Supply and Taxes: Evidence from OECD Countries, 1956-2004," NBER Working Papers 12786, National Bureau of Economic Research, Inc.
    8. Merz, Monika, 1999. "Heterogeneous job-matches and the cyclical behavior of labor turnover," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 91-124, February.
    9. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
    10. Anton A. Cheremukhin & Paulina Restrepo Echavarria, 2008. "The Labor Wedge as a Matching Friction," 2008 Meeting Papers 209, Society for Economic Dynamics.
    11. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
    12. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
    13. Robert Shimer, 2009. "Convergence in Macroeconomics: The Labor Wedge," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 280-97, January.
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