Job Destruction and Propagation of Shocks

Abstract

It has been well documented that the cyclical adjustment of labor input chiefly represents movement of workers into and out of employment, rather than adjustment of hours at given jobs. Thus, in understanding business cycles, it is centrally important to understand the formation and breakdown of employment relationships. The nature of employment adjustments over the cycle has also received close scrutiny. Evidence from a number of sources indicates that recessionary employment reductions are accounted for by elimination of preexisting jobs, i.e., job destruction, to a greater extent than by diminished creation of new jobs. Substantial cyclical variation in the rate of job destruction suggests that closer consideration of the breakdown of employment relationships may help to explain how shocks to the economy generate large and persistent output fluctuations. 1 This paper addresses these issues by studying the endogenous breakup of employment relationships in a dynamic general-equilibrium model with labor-market matching. Production is assumed to entail long-term relationships between workers and firms. We consider a version of Dale T. Mortensen and Christopher A. Pissarides' (1994) model, wherein a worker and firm who are currently matched must decide each period whether to preserve or sever their relationship, based on their current-period productivity. By altering the trade-off between match preservation and severance, aggregate productivity shocks induce fluctuations in the job-destruction rate, thereby exerting effects on output that go beyond those resulting from productivity variations in continuing relationships. We embed the basic Mortensen-Pissarides mechanism into a full dynamic general-equilibrium model, analyze the role of fluctuations in the job-destruction rate in propagating shocks, and assess the model's quantitative implications.Most business-cycle models in the realbusiness-cycle (RBC) tradition share the feature that model-generated output data exhibit dynamic characteristics nearly identical to those of the underlying exogeneous shocks, so that economic mechanisms play a minimal role in propagating shocks (Timothy Cogley and James M. Nason, 1993Nason, , 1995Julio J. Rotemberg and Michael Woodford, 1996). In our model, however, fluctuations in the job-destruction rate give rise to a significant propagation mechanism: productivity shocks are magnified in their effect on output at the point of impact, and the persistence of output effects is greatly increased. Using simulated data from a calibrated version of the model, we find that the standard deviation of output is roughly two and one-half times larger than the standard deviation of the

Along the New Keynesian Phillips Curve with Nominal and Real Rigidities

“…33 The exogenous fixed separation rate equals 0.0848 which helps to set steady state employment and its sample counterpart equal. This calibration of δ N is within the range Merz (1995), Den-Haan, Ramey, and Watson (2000), and Andolfatto (1996) use. The vacancy cost parameter υ = 0.1050 is taken from Andolfatto (1996).…”

“…A real rigidity is integrated into Yun's DSGE model with the labor market-search technology that Merz (1995), Andolfatto (1996), and Den-Haan, Ramey, and Watson (2000) use in a RBC setting. We also study a flexible price version of this DSGE model.…”

“…Advice from Gali and Gertler (1999) suggests we approach this problem by adding a real rigidity, labor market search, to the Yun-sticky price model. The result is a DSGE which integrates the Calvo-staggered price mechanism (1) with the labor search technologies found in the RBC models of Merz (1995), Andolfatto (1996), and Den-Haan, Ramey, and Watson (2000).…”

“…29 Den Haan, Ramey, and Watson (2000) introduce an endogenous separation mechanism into their RBCsearch model. A linear approximation of their model is equivalent to adding an exogenous shock to the separation rate δ N of the law of motion (28).…”

“…We conclude in section 5. 4 Millard, Scott, and Sensier (1999), Den-Haan, Ramey, and Watson (2000), and Hussey (2001) also place labor market search in RBC models.…”