Labor Markets and Business Cycles integrates search and matching theory with the neoclassical growth model to better understand labor market outcomes. Robert Shimer shows analytically and quantitatively that rigid wages are important for explaining the volatile behavior of the unemployment rate in business cycles. The book focuses on the labor wedge that arises when the marginal rate of substitution between consumption and leisure does not equal the marginal product of labor. According to competitive models of the labor market, the labor wedge should be constant and equal to the labor income tax rate. But in U.S. data, the wedge is strongly countercyclical, making it seem as if recessions are periods when workers are dissuaded from working and firms are dissuaded from hiring because of an increase in the labor income tax rate. When job searches are time consuming and wages are flexible, search frictions--the cost of a job search--act like labor adjustment costs, further exacerbating inconsistencies between the competitive model and data.
The book shows that wage rigidities can reconcile the search model with the data, providing a quantitatively more accurate depiction of labor markets, consumption, and investment dynamics. Developing detailed search and matching models, Labor Markets and Business Cycles will be the main reference for those interested in the intersection of labor market dynamics and business cycle research.
Robert Shimer is the Alvin H. Baum Professor in Economics and the College at the University of Chicago.
Introduction vii Preface ix Chapter 1: The Labor Wedge 1 1.1 A Representative-Agent Model 1 1.2 Deriving the Labor Wedge 5 1.3 Measurement 7 1.4 Alternative Specification of Preferences 13 1.5 Preference Shocks 16 1.6 From Hours to Unemployment 18 Chapter 2: Benchmark Search Model: Neutrality 20 2.1 Steady State 21 2.2 Productivity Shocks 32 2.3 The Planner's Problem 41 2.4 Extensions 44 2.5 Discussion 56 Chapter 3: Real Effects of Productivity Shocks 58 3.1 General Preferences 59 3.2 Capital 75 3.3 Shocks to the Employment Exit Probability 104 3.4 Other Shocks 112 Chapter 4: Rigid Wages 113 4.1 Wage Indeterminacy 114 4.2 No Capital 116 4.3 Capital 124 4.4 Using Hours Data to Test the Model 144 Chapter 5: Looking Ahead 155 5.1 Theories of Rigid Wages 155 5.2 Empirical Evidence on Rigid Wages 157 5.3 Alternatives to the Matching Function 158 5.4 Relevance to Other Markets 159 Appendix A. Data 161 References 165 Author Index 171