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Working Paper

Search Frictions and the Labor Wedge

We show that search frictions embedded in an RBC model primarily manifest themselves at the extensive margin. The ability to distinguish between the intensive and extensive margins, however, affects the measurement of the marginal rate of substitution (MRS). In fact, the correct measurement of the MRS, in terms of hours per worker, implies a less variable and procyclical labor wedge than the one found in Chari et al. (2007), especially at low Frisch elasticity. The main result is very robust to alternative wage determination mechanisms, even though implications for employment fluctuations may differ.

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

Pescatori, Andrea, and Murat Tasci. 2012. “Search Frictions and the Labor Wedge.” Federal Reserve Bank of Cleveland, Working Paper No. 11-11R.