Do Matching Frictions Explain Unemployment? Not in Bad Times
Social Science Research Network
This paper proposes a model of the labor market that integrates two sources of unemployment: matching frictions and job rationing. To examine how these two sources interact over the business cycle, I decompose unemployment into a cyclical component-caused by job rationing-and a frictional component-caused by matching frictions. Formally, I define the cyclical component of unemployment as the part that would prevail if recruiting costs were zero, and the frictional component as additional
... s additional unemployment due to positive recruiting costs. I prove that during recessions cyclical unemployment increases, driving the rise in total unemployment, whereas frictional unemployment decreases. Intuitively, in bad times, there are too few jobs, the labor market is slack, recruiting is inexpensive, and matching frictions contribute little to unemployment. I specify a model in which job rationing stems from a small amount of wage rigidity and diminishing marginal returns to labor. In the model calibrated with U.S. data, I find that when unemployment is below 5%, it is only frictional; but when unemployment reaches 9%, frictional unemployment amounts to less than 2% of the labor force, and cyclical to more than 7%.