Business Cycles, Unemployment Insurance, and the Calibration of Matching Models
James S. Costain
This paper theoretically and empirically documents a puzzle that arises when an RBC economy with a job matching function is used to model unemployment. The standard model can generate sufficiently large cyclical fluctuations in unemployment, or a sufficiently small response of unemployment to labor market policies, but it cannot do both. Variable search and separation, finite UI benefit duration, efficiency wages, and capital all fail to resolve this puzzle. However, either sticky wages or match-specific productivity shocks can improve the model's performance by making the firm's flow of surplus more procyclical, which makes hiring more procyclical too.
This paper points out an empirical failing of real business cycle models in which unemployment is endogenized through a matching function. One can easily choose a calibration to make the cyclical fluctuation in unemployment as large in the model as it is in the data, or to make the response of unemployment to a change in the unemployment benefit as small in the model as it is in the data. We show with a simple analytical calculation that in the standard job matching model, one cannot do both: improving the fit along one dimension makes it worse along the other. This conclusion is robust to the inclusion of capital, variable search intensity, variable match separation, or efficiency wages. We also propose two possible resolutions of the problem. Both sticky wages and embodied technological progress raise the business cycle variability of unemployment, without greatly changing the effects of policies, because they both make the flow of surplus to the firm more procyclical.
real business cycles, matching function, unemployment insurance
In order to set up a list of libraries that you have access to,
you must first login
or sign up.
Then set up a personal list of libraries from your profile page by
clicking on your user name at the top right of any screen.