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Search Frictions and the Labor Wedge

Author

Listed:
  • Murat Tasci

    (Federal REserve Bank of Cleveland)

  • Andrea Pescatori

    (IMF)

Abstract
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.

Suggested Citation

  • Murat Tasci & Andrea Pescatori, 2011. "Search Frictions and the Labor Wedge," 2011 Meeting Papers 371, Society for Economic Dynamics.
    • Handle: RePEc:red:sed011:371
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    Cited by:

    1. Inaba, Masaru & Nutahara, Kengo & Shirai, Daichi, 2022. "What drives fluctuations of labor wedge and business cycles? Evidence from Japan," Journal of Macroeconomics, Elsevier, vol. 72(C).
    2. Małgorzata Skibińska, 2015. "What drives the labour wedge? A comparison between CEE countries and the Euro Area," NBP Working Papers 220, Narodowy Bank Polski.
    3. Keiichiro Kobayashi & Daichi Shirai, 2017. "Debt-Ridden Borrowers and Economic Slowdown," CIGS Working Paper Series 17-002E, The Canon Institute for Global Studies.
    4. Beauchemin, Kenneth & Tasci, Murat, 2014. "Diagnosing Labor Market Search Models: A Multiple-Shock Approach," Macroeconomic Dynamics, Cambridge University Press, vol. 18(3), pages 548-572, April.
    5. Mark Bils & Peter J. Klenow & Benjamin A. Malin, 2018. "Resurrecting the Role of the Product Market Wedge in Recessions," American Economic Review, American Economic Association, vol. 108(4-5), pages 1118-1146, April.
    6. Kobayashi, Keiichiro & Shirai, Daichi, 2016. "Heterogeneity And Redistribution In Financial Crises," Macroeconomic Dynamics, Cambridge University Press, vol. 20(6), pages 1527-1549, September.
    7. Cheremukhin, Anton A. & Restrepo-Echavarria, Paulina, 2014. "The labor wedge as a matching friction," European Economic Review, Elsevier, vol. 68(C), pages 71-92.
    8. Shirai, Daichi, 2016. "Persistence and Amplification of Financial Frictions," MPRA Paper 72187, University Library of Munich, Germany.
    9. Epstein, Brendan & Mukherjee, Rahul & Finkelstein Shapiro, Alan & Ramnath, Shanthi, 2020. "Trends in aggregate employment, hours worked per worker, and the long-run labor wedge," MPRA Paper 99289, University Library of Munich, Germany.
    10. Skibińska, Małgorzata, 2016. "What drives the labour wedge? A comparison between CEE countries and the Euro Area," Economic Modelling, Elsevier, vol. 56(C), pages 148-161.
    11. Keiichiro Kobayashi & Daichi Shirai, 2012. "Debt-Ridden Borrowers and Productivity Slowdown," CIGS Working Paper Series 14-005E, The Canon Institute for Global Studies.
    12. Zhang, Lini, 2018. "Credit crunches, individual heterogeneity and the labor wedge," Journal of Macroeconomics, Elsevier, vol. 56(C), pages 65-88.
    13. Anna Watson, 2019. "Financial Frictions, the Great Trade Collapse and International Trade over the Business Cycle," Open Economies Review, Springer, vol. 30(1), pages 19-64, February.
    14. Skibińska, Małgorzata, 2016. "What drives the labour wedge? A comparison between CEE countries and the Euro Area," Economic Modelling, Elsevier, vol. 56(C), pages 148-161.

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    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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