Unemployment and Business Cycles (and a rehabilitation of matching models)

That is a new and important paper by Christiano, Eichenbaum, and Trabandt which strengthens and rehabilitates matching models of the labor market.  The abstract is this:

We develop and estimate a general equilibrium model that accounts for key business cycle properties of macroeconomic aggregates, including labor market variables. In sharp contrast to leading New Keynesian models, wages are not subject to exogenous nominal rigidities. Instead we derive wage inertia from our specification of how firms and workers interact when negotiating wages. Our model outperforms the standard Diamond-Mortensen-Pissarides model both statistically and in terms of the plausibility of the estimated structural parameter values. Our model also outperforms an estimated sticky wage model.

A few points:

1. This model overcomes the empirical problems with matching models stressed by Shimer (2005).

2. In this model the distinction between structural and cyclical unemployment is ill-defined.  To insist that today’s unemployment is one rather than the other is to commit a category mistake.

3. This model very naturally handles the distinction between “sticky wages for workers who already have jobs” and the situation of workers who do not have a job at all.  For most traditional sticky wage theories this is an embarrassment, as quite good theories of incumbent theories cannot be stretched easily to cover sticky reservation wages for the unemployed.

4. This model does not require that any openly available, good for both sides wage bargain is left sitting on the table.

5. In this model money has a positive effect on output and employment, but only by lowering real interest rates and inducing more consumer spending.  It does not in general appear to be a large effect, but there is a real positive effect.  You will note that the underlying parameters of the labor matching model are defined in real terms.

6. This model derives wage inertia and thus matches observed data on “stickiness,” noting that “stickiness” now seems to be a misleading word.

7. It would be a mistake to think that this model (or any) captures the entirety of the U.S. labor market.  Yet if the model reflects a big chunk of our labor market, at the expense of the standard nominal wage stickiness model, that would have significant implications for how we think about monetary and fiscal policies.

8. Unlike in the Keynesian model, I believe in this model it is possible for effective stimulus policy to both improve employment and boost real wages (possibly small amounts).  That is a very common claim (“let’s get some stimulus to boost wages”), yet few people making it realize how much it conflicts with their underlying Keynesian foundations.  Perhaps this is a new way forward.  Please note, however, that is my intuition based upon reading the paper and not a result which the authors have proven formally.

It is oddly fashionable in the economics blogosphere to insist that microfoundations do not matter or are not a worthy matter of study.  Papers like this show that in fact they matter a great deal.

An (earlier?) ungated version of the paper is here.


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