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Diagnosing Labor Market Search Models: A Multiple-Shock Approach

We construct a multiple shock, discrete time version of the Mortensen-Pissarides labor market search model to investigate the basic model’s well-known tendency to underpredict the volatility of key labor market variables. In addition to the standard labor productivity shock, we introduce shocks to matching efficiency and job separation. We conduct two set of experiments. First, we estimate the joint probability distribution of shocks that simultaneously satisfy the observed data and the first-order conditions of the multiple-shock model, and then simulate its properties. Although the multiple-shock model generates significantly more volatility while preserving the Beveridge curve relationship, it generates counterfactual implications for the cyclicality of job separations. Using a business cycle accounting approach, we design the second set of experiments to isolate the sources of model incompleteness and show that the model requires significant procyclical and volatile matching efficiency and counterfactually procyclical job separations to render the observed data without error. We conjecture that the basic Mortensen-Pissarides model lacks mechanisms to generate sufficiently strong labor market reallocation over the business cycle, and suggest nontrivial labor force participation and job-to-job transitions as promising avenues of research. NOTE: This is a substantial revision of working paper 08-13, which is a substantial revision of working paper 07-20.

Key words: Labor Market Search; Mismatch; Business Cycles; Unemployment; Job Vacancies.

JEL classification: E24; E32; J64.

*This paper is a substantially revised version of a paper posted in January 2007 with the same title. The earlier version is available as working paper no. 08-13.

Suggested citation: Beauchemin, Kenneth, and Murat Tasci, 2012. “Diagnosing Labor Market Search Models: A Multiple-Shock Approach,” Federal Reserve Bank of Cleveland, Working Paper no 12-11.

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