The Cyclical Behavior of Equilibrium Unemployment and Vacancies: Evidence and Theory

Abstract

This paper argues that a broad class of search models cannot generate the observed businesscycle-frequency fluctuations in unemployment and job vacancies in response to shocks of a plausible magnitude.In the U.S., the vacancy-unemployment ratio is 20 times as volatile as average labor productivity, while under weak assumptions, search models predict that the vacancy-unemployment ratio and labor productivity have nearly the same variance.I establish this claim both using analytical comparative statics in a very general deterministic search model and using simulations of a stochastic version of the model.I show that a shock that changes average labor productivity primarily alters the present value of wages, generating only a small movement along a downward sloping Beveridge curve (unemployment-vacancy locus).A shock to the job destruction rate generates a counterfactually positive correlation between unemployment and vacancies.In both cases, the shock is only slightly amplified and the model exhibits virtually no propagation.I reconcile these findings with an existing literature and argue that the source of the model's failure is lack of wage rigidity, a consequence of the assumption that wages are determined by Nash bargaining.

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