Unemployment Volatility Puzzle Research Articles

Asset Prices and Unemployment Fluctuations: A Resolution of the Unemployment Volatility Puzzle

Abstract Recent work has demonstrated that existing solutions of the unemployment volatility puzzle are at odds with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model of business cycles that is immune to these critiques by incorporating two key features. First, we allow for preferences that generate time-varying risk over the business cycle to account for observed fluctuations in asset prices. Second, we introduce human capital acquisition, as is consistent with the evidence on how wages grow with experience in the labor market. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration returns. As in the data, the price of risk in our model sharply increases in recessions. The benefit from hiring new workers therefore greatly declines, leading to a large decrease in job vacancies and an increase in unemployment of the same magnitude as in the data. We show that our results extend to versions of the model that include physical capital, a life cycle for workers, and alternative preference structures common in the asset-pricing literature.

Asset Prices and Unemployment Fluctuations: A Resolution of the Unemployment Volatility Puzzle

Asset Prices and Unemployment Fluctuations: A Resolution of the Unemployment Volatility Puzzle

A note on the unemployment volatility puzzle

Abstract This paper features an economy with frictional labour markets, Nash bargaining, cyclical opportunity cost of employment and demand-determined output. I show that the model generates big responses of unemployment to productivity movements. The key insight is that strongly countercyclical markups amplify the impact of aggregate shocks on the fundamental surplus, and as a consequence, on labour market outcomes. This answers the critique of Chodorow-Reich and Karabarbounis that the cyclicality of the opportunity cost poses a challenge to the solution of the unemployment volatility puzzle.

Asset Prices and Unemployment Fluctuations: A Resolution of the Unemployment Volatility Puzzle

Asset Prices and Unemployment Fluctuations: A Resolution of the Unemployment Volatility Puzzle

Uniform nonparametric inference for time series

This paper provides the first result for the uniform inference based on nonparametric series estimators in a general time-series setting. We develop a strong approximation theory for sample averages of mixingales with dimensions growing with the sample size. We use this result to justify the asymptotic validity of a uniform confidence band for series estimators and show that it can also be used to conduct nonparametric specification test for conditional moment restrictions. New results on the validity of heteroskedasticity and autocorrelation consistent (HAC) estimators with increasing dimension are established for making feasible inference. An empirical application on the unemployment volatility puzzle for the search and matching model is provided as an illustration.

Endogenous Labor Market Cycles

This paper shows that in a perfectly stationary physical environment of the labor market, moral hazard and competition in long-term contracts can generate cycles in the tightness of the market, which in turn may induce job creation and destruction, and two periods or much longer cycles in employment and output. We claim that the model may shed light on the unemployment volatility puzzle, which has inspired many discussions in the literature.

Uniform Nonparametric Series Inference for Dependent Data with an Application to the Search and Matching Model

This paper concerns the uniform inference for nonparametric series estimators in time-series applications. We develop a strong approximation theory of sample averages of serially dependent random vectors with dimensions growing with the sample size. The strong approximation is first proved for heterogeneous martingale difference arrays and then extended to general mixingales via martingale approximation, readily accommodating a majority of applications in applied econometrics. We use these results to justify the asymptotic validity of a uniform confidence band for series estimators and show that it can also be used to conduct nonparametric specification test for conditional moment restrictions. The validity of high-dimensional heteroskedasticity and autocorrelation consistent (HAC) estimators is established for making feasible inference. The proposed method is broadly useful for forecast evaluation, empirical microstructure, dynamic stochastic equilibrium models and inference problems based on inter-section bounds. We demonstrate the empirical relevance of the proposed method by studying the Mortensen–Pissarides search and matching model for equilibrium unemployment, and shed new light on the unemployment volatility puzzle from an econometric perspective.

Alternating offers with asymmetric information and the unemployment volatility puzzle

To provide micro-founded real wage rigidities, the literature on the unemployment volatility puzzle has considered alternating offers on one side, and asymmetric information on the other. Separately, however, these two frameworks deliver a limited amount of wage stickiness and thus require questionable calibrations to raise unemployment fluctuations. In this paper, we argue that the alternating offers model with one-sided asymmetric information, which combines the two frameworks, gives a more satisfactory answer to the puzzle. The results are improved along two dimensions. First, we show that this model is capable to generate large unemployment movements for a realistic calibration. Secondly, the model produces a right degree of real wage pro-cyclicality for such a calibration and therefore delivers a micro-founded explanation to real wage rigidities.

Heterogeneity in Staggered Wage Bargaining and Unemployment Volatility Puzzle

It has been noted that the search and matching model cannot account for the observed unemployment fluctuations. Gertler and Trigari (2009) show this weakness of the model disappears when wage stickiness is introduced to the model. Pissarides (2009) disagrees with this modification, arguing that new hires’ wages are not sticky. We argue that there is heterogeneity in wage setting: while some wages are sticky, the others are not. We generalise the model to account for this heterogeneity. We find that the new model with even only a small fraction of sticky wage contracts comes closer to matching the data.

Adaptive Learning and Labour Market Dynamics

It is well known that the standard search and matching model with Rational Expectations (RE) is unable to generate amplification in unemployment and vacancies. We show that relaxing the RE assumption has the potential to provide a solution to this well known unemployment volatility puzzle. A model in which agents use Recursive Least Square algorithms to update their expectations as new information becomes available is presented. Firms choose vacancies by making infinite horizon forecasts over (un)employment rates, wages and interest rates at each point in time. Firms have much greater incentive for vacancy posting because of overoptimism about the discounted value of expected profits at the time a positive TFP shock hits the economy. The model with adaptive learning is able to match the relative volatility of labour market variables in US data and the properties of forecast errors of unemployment rates obtained from the Survey of Professional Forecasters.

The Cyclical Volatility of Equilibrium Unemployment and Vacancies: Evidence From Italy

AbstractIn this study, we explore the fluctuations of unemployment and vacancies in the Italian labour market over the last 20 years. Relying on the available sources of data for unfilled job openings, we find that even in Italy, similarly to other developed countries, there is a clean evidence of the unemployment volatility puzzle. In other words, we empirically assess that the tightness indicator is significantly more volatile than productivity over the whole period. In addition, on the theoretical ground, we show that a matching model with segmented labour markets and on‐the‐job search has the potential to provide a rationale for this pattern.

Real wage rigidity and the unemployment volatility puzzle in small open economies

Standard search models of the labour market feature a volatility puzzle: labour market variables move too little in response to productivity shocks. I investigate if real wage rigidity is sufficient to solve this in an open economy. Starting from a closed economy benchmark in which wage rigidity makes labour market variables sufficiently volatile, I find that the puzzle reopens in the open economy, despite a rigid real wage. This is because terms of trade movements move the wedge between the consumer and producer real wage in such a way that labour market variables respond less to productivity shocks. A quantitative exercise shows that the effect of this mechanism can be sizeable.

Working capital requirement and the unemployment volatility puzzle

Shimer (2005) argues that a search and matching model of the labor market in which wage is determined by Nash bargaining cannot generate the observed volatility in unemployment and vacancy in response to reasonable labor productivity shocks. This paper examines how incorporating monopolistically competitive firms with a working capital requirement (in which firms borrow funds to pay their wage bills) improves the ability of the search models to match the empirical fluctuations in unemployment and vacancy without resorting to an alternative wage setting mechanism. The monetary authority follows an interest rate rule in the model. A positive labor productivity shock lowers the real marginal cost of production and lowers inflation. In response to the fall in price level, the monetary authority reduces the nominal interest rate. A lower interest rate reduces the cost of financing and partially offsets the increase in labor cost from a higher productivity. A reduced labor cost implies the firms retain a greater portion of the gain from a productivity shock, which gives them a greater incentive to create vacancies. Simulations show that a working capital requirement does indeed improve the ability of the search models to generate fluctuations in key labor market variables to better match the U.S. data.

The Unemployment Volatility Puzzle: A Note on the Role of Reference Points

This theoretical note aims at studying the role of reference points in generating unemployment volatility. For this purpose, I introduce the notion of reference points in a standard Mortensen-Pissarides model. I obtain two results. First, I find that the obtained model is similar to the one found by Pissarides in 2009. Second, I show that the introduction of reference points can increase significantly unemployment volatility through a mechanism a la Hagerdorn and Manovskii.

Elasticity of Intertemporal Substitution and Unemployment Volatility

This paper studies how the elasticity of intertemporal substitution (EIS) influences labor market fluctuations in the labor search and matching model with both extensive and intensive margins of labor supply. With the curvature of utility, the countercyclical marginal utility of consumption induces the flow value of unemployment to be procyclical, and the stock returns to be countercyclical. The former effect reduces unemployment volatility by weakening wage rigidity. In contrast, the latter effect magnifies unemployment volatility by discounting higher future payoffs from hiring at a lower discount rate, if wages do not absorb all of productivity shocks. The higher EIS reduces the procyclicality of the flow value of unemployment, and reinforces the countercyclicality of the stock returns. We quantitatively show that a high level of the EIS is required to resolve the unemployment volatility puzzle.

The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?

The author discusses the failure of the canonical search and matching model to explain the cyclical volatility in the job finding rate. The author - the Nobel Prize winner in economics in 2010 - shows that job creation in the model is influenced by wages in new matches. He summarizes microeconometric evidence and finds that wages in new matches are volatile and consistent with the models key predictions. Therefore, explanations of the unemployment volatility puzzle have to preserve the cyclical volatility of wages. The author discusses a modification of the model, based on fixed matching costs, that can increase cyclical unemployment volatility and is consistent with wage flexibility in new matches.

On the Dynamics of Unemployment and Wage Distributions

Postel-Vinay and Robin's (2002) sequential auction model is extended to allow for aggregate productivity shocks. Workers exhibit permanent differences in ability while firms are identical. Negative aggregate productivity shocks induce job destruction by driving the surplus of matches with low ability workers to negative values. Endogenous job destruction coupled with worker heterogeneity thus provides a mechanism for amplifying productivity shocks that offers an original solution to the unemployment volatility puzzle (Shimer (2005)). Moreover, positive or negative shocks may lead employers and employees to renegotiate low wages up and high wages down when agents' individual surpluses become negative. The model delivers rich business cycle dynamics of wage distributions and explains why both low wages and high wages are more procyclical than wages in the middle of the distribution.

Real Wages and the Business Cycle: Accounting for Worker and Firm Heterogeneity

Using a longitudinal matched employer-employee data set for Portugal over the 1986-2005 period, this study analyzes the heterogeneity in wages responses to aggregate labor market conditions for newly hired workers and existing workers. Controlling simultaneously for worker and firm specifi ce ffects, the results show that entry wages are much more procyclical than current wages. A one-point increase in the unemployment rate decreases wages of newly hired male workers by around 2.5% and by just 1.5% for workers in continuing jobs. For female workers these same effects are 2.3% and 1.1%, respectively. Thus, our empirical evidence does not seem to lend support to the hypothesis of wage stickiness as an explanation for the unemployment volatility puzzle. JEL classification: J31; E24; E32;

Productivity and Job Flows: Heterogeneity of New Hires and Continuing Jobs in the Business Cycle

This paper focuses on tenure driven productivity dynamics of a firm-worker match as a potential explanation of unemployment volatility puzzle. We let new matches and continuing jobs differ by their productivity levels and by their sensitivity to aggregate productivity shocks. As a result, new matches have a higher destruction rate and lower, but more volatile, wages than old matches, as new hires receive technology associated with the latest vintage. Our contribution is to produce model driven stickiness of old jobs' wages which does not rely on ad hoc assumptions on wage rigidity. In our model, an aggregate productivity shock generates a persistent productivity difference between the two types of matches, creating an incentive to open new productive vacancies and to destroy old matches that are temporarily less productive. The model produces a well behaving Beveridge curve, despite endogenous job destruction, and more volatile vacancies and unemployment, without a need to rely on differing wage setting mechanisms of new and continuing jobs. Price rigidities do not alter the basic mechanism and the transmission of monetary policy shock is very similar to the standard New Keynesian model with search frictions. JEL Classification: E24, E32, J64

The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?

I discuss the failure of the canonical search and matching model to match the cyclical volatility in the job finding rate. I show that job creation in the model is influenced by wages in new matches. I summarize microeconometric evidence and find that wages in new matches are volatile and consistent with the model's key predictions. Therefore, explanations of the unemployment volatility puzzle have to preserve the cyclical volatility of wages. I discuss a modification of the model, based on fixed matching costs, that can increase cyclical unemployment volatility and is consistent with wage flexibility in new matches.