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Working Paper

Diagnosing Labor Market Search Models: A Multiple-Shock Approach

We construct a multiple-shock 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. Data on U.S. job nding and job separation probabilities are used to help estimate the parameters of a three-dimensional shock process comprising labor productivity, job separation, and matching or “allocative” efficiency. Although our multiple-shock model generates some more volatility, it has counterfactual implications for the cyclicality of unemployment and vacancies. Our second exercise forces the model to be the data-generating process to uncover the necessary realizations of all three shocks. We show that the Mortensen-Pissarides labor market search model requires significantly procyclical and volatile matching efficiency and job separations to simultaneously account for high procyclical variations in job nding probabilities as well as relatively small net employment changes in the data. Hence, the model is more fundamentally fl awed than its inability to amplify shocks would suggest. We also show that variation in job separations accounts for most of the employment fluctuations, suggesting that endogenous separations could be the key feature of an improved model. This leads us to conclude that the model lacks mechanisms to generate procyclical matching efficiency and labor force reallocation. As for the latter, we conjecture that nontrivial labor force participation and job-to-job transitions are promising avenues of research.

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.


Suggested Citation

Beauchemin, Kenneth R., and Murat Tasci. 2008. “Diagnosing Labor Market Search Models: A Multiple-Shock Approach.” Federal Reserve Bank of Cleveland, Working Paper No. 08-13. https://doi.org/10.26509/frbc-wp-200813