Empirical evidence suggests that labour market variables such as vacancies
and unemployment display high volatility over the business cycle. In a
seminal study, Shimer (2005) shows that the standard search and matching
model driven purely by Total Factor Productivity (TFP) innovations is unable
to match the volatility of labour market variables as observed in the US
data. This lack of amplification is known in the literature as the
unemployment volatility puzzle. Our research shows that addressing this
anomaly is important not only from a quantitative perspective but also from
the point of view of policy.
Our research argues that the performance of the standard search and matching
model can be improved by introducing deep habits in consumption. The deep
habits mechanism changes the pricing incentive of firms relative to the
model with superficial habits. After a positive TFP innovation firms have a
further incentive to lower prices and to increase their customer base. But,
by lowering prices, their demand for goods increases and, as a result, firms
create new vacancies and hire more workers in equilibrium in order to meet
the increase in demand.
A well-known fact in macroeconomics is that durable expenditure is highly
volatile over the business cycle. Moreover, microeconometric evidence shows
that durable prices are more flexible durable than non-durable prices. We
show, through the lenses of a two-sector model featuring durable good
production, flexible durable prices and sticky non-durable prices, that the
lack of amplification in labour market variables can generate monetary
neutrality. Our research argues that generating amplification in labour
market variables is crucial for restoring the non-neutrality result that is
characteristics of New Keynesian models.
Researcher: Federico Di Pace
"Deep Habits and the Cyclical Behaviour of Equilibrium Unemployment and Vacancies", Journal of Economic Dynamics and Control, Volume 36, Issue 2, February 2012, Pages 183-200 (with Renato
Faccini)
"Labour Market Frictions, Monetary Policy and Durable Goods", Working Paper Series of the Department of Economics, University of Konstanz, Issue 2012-09 (with Matthias
Hertweck)
