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ifdp1089.pdf

ifdp1089.pdf

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Published by TBP_Think_Tank
Unemployment and Business Cycles
Unemployment and Business Cycles

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Published by: TBP_Think_Tank on Oct 23, 2013
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01/21/2014

 
 Board of Governors of the Federal Reserve SystemInternational Finance Discussion Papers Number 1089September 2013
Unemployment and Business Cycles
Lawrence J. Christianoand Martin S. Eichenbaumand Mathias Trabandt NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulatediscussion and critical comment. References to International Finance Discussion Papers (other than an acknowledgment that the writer has had access to unpublished material) should becleared with the author or authors. Recent IFDPs are available on the Web atwww.federalreserve.gov/pubs/ifdp/.This paper can be downloaded without charge from theSocial Science Research Network electronic library at www.ssrn.com.
 
Unemployment and Business Cycles
Lawrence J. Christiano
y
Martin S. Eichenbaum
z
Mathias Trabandt
x
July 19, 2013
Abstract
We develop and estimate a general equilibrium model that accounts for key businesscycle properties of macroeconomic aggregates, including labor market variables. Insharp contrast to leading New Keynesian models, wages are not subject to exogenousnominal rigidities. Instead we derive wage inertia from our speciÖcation of how Örmsand workers interact when negotiating wages. Our model outperforms the standardDiamond-Mortensen-Pissarides model both statistically and in terms of the plausibilityof the estimated structural parameter values. Our model also outperforms an estimatedsticky wage model.
 Keywords: unemployment, business cycles, wage inertia, Bayesian estimationJEL: E2, E24, E32
The views expressed in this paper are those of the authors and do not necessarily reáect those of theBoard of Governors of the Federal Reserve System or of any other person associated with the Federal ReserveSystem.
y
Northwestern University, Department of Economics, 2001 Sheridan Road, Evanston, Illinois 60208, USA.Phone: +1-847-491-8231. E-mail: l-christiano@northwestern.edu.
z
Northwestern University, Department of Economics, 2001 Sheridan Road, Evanston, Illinois 60208, USA.Phone: +1-847-491-8232. E-mail: eich@northwestern.edu.
x
Board of Governors of the Federal Reserve System, Division of International Finance, Trade and Fi-nancial Studies Section, 20th Street and Constitution Avenue N.W, Washington, DC 20551, USA, E-mail:mathias.trabandt@gmail.com.
 
1. Introduction
Employment and unemployment áuctuate a great deal over the business cycle. Macroeco-nomic models have di¢culty accounting for this fact. See for example the classic real busi-ness cycle models of Kydland and Prescott (1982) and Hansen (1985). Models that buildon the search-theoretic framework of Diamond (1982), Mortensen (1985) and Pissarides(1985) (DMP) also have di¢culty accounting for the volatility of labor markets, see Shimer(2005a). In both classes of models, the problem is that real wages rise sharply in businesscycle expansions, thereby limiting Örmsí incentives to expand employment. The proposedsolutions depend on controversial assumptions, such as high labor supply elasticities or highreplacement ratios.
1
Empirical New Keynesian models have been relatively successful in accounting for thecyclical properties of employment. However, they do so by assuming that wage-setting is sub- ject to nominal rigidities and that employment is demand-determined.
2
These assumptionsprevent the sharp rise in wages that limits the employment responses in standard models.Empirical New Keynesian models have been criticized on at least four grounds. First, thesemodels do not explain wage inertia, they just assume it. Second, agents in the model wouldnot choose the wage arrangements that are imposed upon them by the modeler.
3
Third,empirical New Keynesian models are inconsistent with the fact that many wages are con-stant for extended periods of time. In practice, these models assume that agents who do notreoptimize their wage simply index it to technology growth and ináation.
4
So, these modelspredict that all wages are always changing. Fourth, these models cannot be used to examinesome key policy issues such as the e§ects of an extension of unemployment beneÖts.In this paper we develop and estimate a model that accounts for the response of keymacro aggregates, including labor market variables like wages, employment, job vacanciesand unemployment to identiÖed monetary policy shocks, neutral technology shocks andinvestment-speciÖc technology shocks. In contrast to leading empirical New Keynesian mod-els, we do not assume that wages are subject to exogenous nominal rigidities. Instead, wederive wage inertia as an equilibrium outcome. Like empirical New Keynesian models, we
1
For discussions of high labor supply elasticities in real business cycle models, see for example, Rogersonand Wallenius (2009) and Chetty, Guren, Manoli and Weber (2012). For discussions of the role of highreplacement ratios in DMP models see for example, Hagedorn and Manovskii (2008) and Hornstein, Kruselland Violante (2010).
2
For example, Christiano, Eichenbaum and Evans (2005), Smets and Wouters (2003, 2007) and Gali,Smets and Wouters (2012) assume that nominal wages are subject to Calvo-style rigidities.
3
This criticsm does not necessarily apply to a class of models initially developed by Hall (2005). Wediscuss these models in the conclusion.
4
See, for example, Christiano, Eichenbaum and Evans (2005), Smets and Wouters (2007), Justiniano,Primiceri and Tambalotti (2010), Christiano, Trabandt and Walentin (2011), and Gali, Smets and Wouters(2012).
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