Job separation shocks, costly vacancy creation and job rationing

This paper demonstrates that accurately assessing the roles of matching frictions and job rationing in U.S. unemployment requires a model that captures the observed decrease in labor market tightness following a job separation shock. The free entry version of the job rationing model underestimates the impact of matching frictions, instead emphasizing job rationing as the primary driver of U.S. unemployment, because it produces a counterfactual increase in tightness, which raises the job-finding rate and reduces unemployment attributed to matching frictions. Conversely, the costly entry version, which incorporates vacancy creation costs, accurately reproduces the observed decline in tightness, indicating that U.S. unemployment is primarily driven by matching frictions. The response of labor market tightness to a job separation shock is shaped by two opposing effects: the marginal product effect, which increases tightness, and the capitalization effect, which decreases tightness. Including vacancy creation costs strengthens the capitalization effect, outweighing the marginal product effect, and results in the observed decline in tightness. These findings underscore the importance of incorporating vacancy creation costs to accurately measure the impact of matching frictions on unemployment.