Business Cycles in the Equilibrium Model of Labor Market Search and Self-Insurance

44 Pages Posted: 17 Aug 2010

See all articles by Makoto Nakajima

Makoto Nakajima

Federal Reserve Bank of Philadelphia

Multiple version iconThere are 3 versions of this paper

Date Written: August 5, 2010


The author introduces risk-averse preferences, labor-leisure choice, capital, individual productivity shocks, and market incompleteness to the standard Mortensen-Pissarides model of search and matching and explore the model's cyclical properties. There are four main findings. First and foremost, the baseline model can generate the observed large volatility of unemployment and vacancies with a realistic replacement ratio of the unemployment insurance benefits of 64 percent. Second, labor-leisure choice plays a crucial role in generating the large volatilities; additional utility from leisure when unemployed makes the value of unemployment close to the value of employment, which is crucial in generating a strong amplification, even with the moderate replacement ratio. Besides, it contributes to the amplification through an adjustment in the intensive margin of labor supply. Third, the borrowing constraint or uninsured individual productivity shocks do not significantly affect the cyclical properties of unemployment and vacancies: Most workers are well insured only with self-insurance. Fourth, the model better replicates the business cycle properties of the U.S. economy, thanks to the co-existence of adjustments in the intensive and extensive margins of labor supply and the stronger amplification.

Keywords: Search, Matching, Business Cycles, Labor Markets, General Equilibrium, Incomplete Markets, Computational Methods

JEL Classification: D52, E24, E32, J64

Suggested Citation

Nakajima, Makoto, Business Cycles in the Equilibrium Model of Labor Market Search and Self-Insurance (August 5, 2010). FRB of Philadelphia Working Paper No. 10-24, Available at SSRN: or

Makoto Nakajima (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
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