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The Consumption-Tightness Puzzle

In: NBER International Seminar on Macroeconomics 2006

  • Morten O. Ravn

This paper introduces a labor force participation choice into a labor market matching model embedded in a dynamic stochastic general equilibrium set-up with production and savings. The participation choice is modelled as a tradeoff between forgoing the expected benefits of being search active and engaging in costly labor market search. The model induces a symmetry in firms%u2019 and workers%u2019 search decision since both sides of the labor market vary search effort at the extensive margins. We show that this set-up is of considerable analytical convenience and that it gives rise to a linear relationship between labor market tightness and the marginal utility of consumption. We refer to the latter as the %u201Cconsumption - tightness puzzle%u201D because (a) it gives rise to a number of counterfactual implications, and (b) it is a robust implication of theory. Amongst the counterfactual implications are very low volatility of tightness, procyclical unemployment, and a positively sloped Beveridge curve. These implications all derive from procyclical variations in participation rates that follow from allowing for the extensive search margin.

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This chapter was published in:
  • Lucrezia Reichlin & Kenneth West, 2008. "NBER International Seminar on Macroeconomics 2006," NBER Books, National Bureau of Economic Research, Inc, number reic08-1, June.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 7034.
    Handle: RePEc:nbr:nberch:7034
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