Why does employment in all major sectors move together over the business cycle?

Abstract

The labor input is correlated across all major sectors. I argue that this mostly stems from fluctuations in employment, rather than hours. Therefore, it is crucial to understand the cross-sector correlation of the extensive margin. This paper advances the literature on cross-sector correlations by making unemployment an explicit feature of the model. I construct a two-sector model with search and matching friction, wage rigidity, and capital adjustment costs. The model explains the positive cross-sector correlation through characterizing movements into and out of unemployment in both sectors. Moreover, the results suggest a link between the “co-movement” and the “unemployment volatility” puzzles.