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Labor Markets and Business Cycles

Labor Markets and Business Cycles

Robert Shimer
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  • Book Info
    Labor Markets and Business Cycles
    Book Description:

    Labor Markets and Business Cyclesintegrates search and matching theory with the neoclassical growth model to better understand labor market outcomes. Robert Shimer shows analytically and quantitatively that rigid wages are important for explaining the volatile behavior of the unemployment rate in business cycles.

    The book focuses on the labor wedge that arises when the marginal rate of substitution between consumption and leisure does not equal the marginal product of labor. According to competitive models of the labor market, the labor wedge should be constant and equal to the labor income tax rate. But in U.S. data, the wedge is strongly countercyclical, making it seem as if recessions are periods when workers are dissuaded from working and firms are dissuaded from hiring because of an increase in the labor income tax rate. When job searches are time consuming and wages are flexible, search frictions--the cost of a job search--act like labor adjustment costs, further exacerbating inconsistencies between the competitive model and data. The book shows that wage rigidities can reconcile the search model with the data, providing a quantitatively more accurate depiction of labor markets, consumption, and investment dynamics.

    Developing detailed search and matching models,Labor Markets and Business Cycleswill be the main reference for those interested in the intersection of labor market dynamics and business cycle research.

    eISBN: 978-1-4008-3523-2
    Subjects: Business, Economics

Table of Contents

  1. Introduction
    (pp. vii-viii)

    The Center for Research in International Economics (CREI) aims to deepen our understanding of the global forces that shape modern economies. CREI was founded in 1994 with support from the Generalitat de Catalunya and Universitat Pompeu Fabra (UPF). It is dedicated to generating research of the highest quality, in all areas of macroeconomics—ranging from growth, international finance, business cycles, the study of labor markets, and monetary economics to trade, development, and international economic history.

    The CREI Lectures in Macroeconomics will present new work by young but already distinguished scholars, whose recent contributions have already had a substantial impact on...

  2. 1 The Labor Wedge
    (pp. 1-19)

    Throughout this book, I study the interaction of optimizing households and firms in a closed economy. I begin in this chapter by developing a competitive, representative-agent version of the model. The chapter has two objectives. First, I introduce much of the notation that I rely on throughout the book. Because of this, I include details in this chapter that are not really necessary for the second, more substantive objective: I use the model to measure and analyze the behavior of thelabor wedge, the wedge between the marginal rate of substitution of consumption for leisure and the marginal product of...

  3. 2 Benchmark Search Model: Neutrality
    (pp. 20-57)

    In this chapter I develop a benchmark search model. A representative firm allocates workers between two activities: production and recruiting. Recruiters enable the firm to attract more workers, while producers generate revenue by creating a consumption good. There is no capital in the model, so production uses only labor and equilibrium savings are zero. Employed workers are periodically hit by shocks that leave them unemployed, while unemployed workers find jobs when they contact a recruiter. Workers’ preferences are additively separable over time and between consumption and leisure, and they are consistent with balanced growth. A government levies a labor income...

  4. 3 Real Effects of Productivity Shocks
    (pp. 58-112)

    I now extend the benchmark search model to study environments in which productivity shocks affect employment. The assumptions that drive the exact neutrality result in chapter 2 are special, in the sense that many modifications of the model imply that unemployment fluctuates cyclically. The modifications I consider here are based on two criteria: tractability and empirical relevance.

    I start, in section 3.1, with the easiest modification of the benchmark model: an alternative formulation of preferences. More precisely, I maintain the assumption that preferences are consistent with balanced growth, but I relax the assumption that the intertemporal elasticity of substitution in...

  5. 4 Rigid Wages
    (pp. 113-154)

    The search models in chapters 2 and 3 make two significant departures from the frictionless model in chapter 1. The first is of course the introduction of search frictions. In the search model, firms use some of their employees to recruit new workers, and the difficulty of recruiting depends on the ratio of recruiters to unemployed workers. The second departure is the determination of wages. Although perhaps more subtle, this assumption is no less important. In the presence of search frictions, matched workers and firms are in a bilateral monopoly situation. Standard arguments that competitive forces equate the wage both...

  6. 5 Looking Ahead
    (pp. 155-160)

    My goal throughout this book has been to present an internally consistent model that can help to explain the observed cyclical behavior of the U.S. labor market. I end this book on a more speculative note, conjecturing how this research agenda might continue to progress. I point to some recent theoretical research that provides a better foundation for why wages are rigid and some recent empirical research that uses microeconomic data to assess the extent of wage rigidity. I discuss some of my own research that questions whether the matching function approach that I use throughout this book is the...