The Hartz reforms, the German Miracle, and labor reallocation

We analyse the recent history of unemployment and labor reallocation in the German economy using a variant of Lucas and Prescott’s (1974) reallocation model, modified to include unemployment benefits, rest unemployment, and aggregate shocks. We focus on the implied effects of the Hartz reforms and the Great Recession in the model, and compare them with the corresponding movements in German data. We find that the model’s qualitative predictions for reallocation and unemployment correspond well with the observations. When we calibrate the model to assess its quantitative performance, however, we find that it significantly overestimates the changes of both reallocation and unemployment since the introduction of the Hartz reforms.