A Forest Fire Theory of the Duration of a Boom and the Size of a Subsequent Bust
Matthew O. Jackson
Stanford University - Department of Economics; Santa Fe Institute; Canadian Institute for Advanced Research (CIFAR)
Stanford University - Department of Economics
We analyze a class of models of matching from firms' perspectives (that nest most standard search models), and show that all such models yield nonstationary use of inputs in response to stationary exogenous shocks. Focusing on labor search as a leading example, in presence of search frictions, firms prefer to hire low productivity workers in high-demand states to take advantage of current profit opportunities. This implies that bad matches accumulate during upswings, leading to drops in employment, and other inputs, that are positively related to the length of the upswing when a negative shock eventually hits: the longer since the last downturn, the larger (absolute and percentage) drop in the employment of labor and capital inputs.
We complement this theoretical result along with empirical evidence for this phenomenon, using US micro-data. We find that five additional years of expansion lead to an additional drop of thirty percent in employment growth at the onset of a downturn.
Number of Pages in PDF File: 52
Keywords: recessions, employment, unemployment, matching, search, business cycles, macro-dynamics
JEL Classification: E24, E32, D92, D21, D22
Date posted: July 8, 2013 ; Last revised: February 16, 2015
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