The Importance of Hiring Frictions in Business Cycles

Abstract

The paper shows that there is an important direct role for hiring frictions in business cycles. This runs counter to key models in several strands of the macroeconomic literature, which imply that hiring frictions are not important per-se. In our model, conventional shocks yield non-standard and non-obvious macroeconomic outcomes in the presence of hiring frictions. Specifically, hiring frictions operate to offset, and possibly reverse, the effects of price frictions. This confluence of frictions has substantial effects. For a sub-set of the parameter space, model outcomes appear “frictionless,” though both hiring frictions and price frictions are at play. For a different sub-space, these interactions between the two frictions generate amplification in the responses of employment and unemployment to technology shocks, rather than friction-induced mitigation of responses. Despite the presence of price rigidity, positive technology shocks may still be expansionary in employment, and the effects of monetary policy shocks may still be negligible. We explain the underlying economic mechanisms and show their empirical implementation. In doing so, we argue in favor of the importance of explicitly using hiring frictions in business cycle modelling.