We study Switzerland’s weak growth during the 1990s through the lens of the business cycle accounting framework of Chari et al. (Econometrica 75(3):781–836, 2007). Our main result is that weak productivity growth cannot account for the 1993–1996 stagnation episode. Rather, the stagnation is explained by factors that made labour and investment expensive. We show that increased labour income taxes and financial frictions are plausible causes. Holding these factors constant, the counterfactual annualized real output growth over the 1993Q1–1996Q4 period is 1.93% compared to realized growth of 0.35%.

Using a search and matching model with distinct intensive and extensive labour margin choices and costly firing, we argue that firing costs can account for the observed cross-country differences in the cyclical behaviour of labour market aggregates. More restrictive employment protection legislation is associated with larger fluctuations in job-creation relative to job-destruction flows, larger fluctuations in the intensive relative to extensive margin of labour, and a weaker short-run Beveridge curve relation measured as the negative contemporaneous correlation between unemployment and vacancies. A calibrated version of our model can explain these empirical observations quantitatively. In the model, firms opt to adjust labour input more strongly along the hiring margin and the intensive margin of labour when firing costs are increased. Hence fluctuations in the job-creation relative to job-destruction flows, and fluctuations in the intensive relative to extensive margin of labour rise. Because hiring takes longer than firing, the substitution of the firing margin with the hiring margin leads to a more sluggish response of unemployment to shocks and hence weakens the negative contemporaneous correlation between unemployment and vacancies.

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