The Cyclical Volatility of Labor Markets Under Frictional Financial Markets

37 Pages Posted: 24 Aug 2010

See all articles by Nicolas Petrosky-Nadeau

Nicolas Petrosky-Nadeau

Federal Reserve Banks - Federal Reserve Bank of San Francisco

Etienne Wasmer

Observatoire Fran├žais des Conjonctures Economiques (OFCE); Sciences Po; IZA Institute of Labor Economics; Centre for Economic Policy Research (CEPR)

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Abstract

Financial frictions are known to raise the volatility of economies to shocks (e.g. Bernanke andGertler 1989). We follow this line of research to the labor literature concerned by the volatility of labor market outcomes to productivity shocks initiated by Shimer (2005): in an economy with search on credit and labor markets, a financial multiplier raises the elasticity of labor market tightness to productivity shocks. This multiplier increases with total financial costs and is minimized under a credit market Hosios-Pissarides rule. Using a flexible calibration method based on small perturbations, we find the parameter values to match the US share of the financial sector. Those values are far away from Hosios and lead to a financial accelerator of about 3.6 (exogenous wages) to 4.5 (endogenous wages). Both match Shimer (2005)'s elasticity of labor market tightness to productivity shocks. Financial frictions are thus an alternative to the "small labor surplus" assumption in Hagedorn and Manovskii (2008): we keep the value of wages over productivity below 0.78. We conclude that financial frictions are a good candidate to solve the volatility puzzle and rejoin Pissarides (2009) in arguing that hiring costs must be partly non-proportional to congestion in the labor market, which is the case of financial costs.

Keywords: search, financial imperfections, Shimer puzzle, macroeconomic volatility

JEL Classification: E44, J60

Suggested Citation

Petrosky-Nadeau, Nicolas and Wasmer, Etienne, The Cyclical Volatility of Labor Markets Under Frictional Financial Markets. IZA Discussion Paper No. 5131. Available at SSRN: https://ssrn.com/abstract=1663171

Nicolas Petrosky-Nadeau (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Etienne Wasmer

Observatoire Fran├žais des Conjonctures Economiques (OFCE) ( email )

69 Quai d'Orsay
Paris 75004
France

Sciences Po

56 rue Jacob
Paris Cedex 07, 75337
France

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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