A Search Theory of Sectoral Reallocation

Abstract

This paper contributes a theoretical framework to analyze how the labor market responds differently to aggregate and sectoral shocks in the presence of search frictions and imperfect mobility. In contrast to the previous literature, which views sectoral shocks as exogenous shocks on matching efficiency, the aggregate impacts of a sectoral shock are the endogenous outcome of the optimal hiring and moving decisions of firms and workers. The model predicts that the economy features the following distinct responses to a structural change: 1) matching efficiency drops and recovers slowly; 2) total vacancies first decrease and then overshoot their long-term equilibrium value; 3) the aggregate wage jumps while labor productivity drops during the transition; and 4) counter-intuitively, the impact on the overall unemployment is limited.

Keywords: Search frictions, Sectoral Reallocation, Mismatch, Unemployment.

JEL Classification: E24, J63, J64