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Search Frictions and the Labor Wedge

  • Murat Tasci

    (Federal REserve Bank of Cleveland)

  • Andrea Pescatori

    (IMF)

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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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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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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