By Jordi Galí and Thijs van Rens
We document three changes in postwar US macroeconomic dynamics: (i) the procyclicality of labor productivity has vanished, (ii) the relative volatility of employment has risen, and (iii) the relative (and absolute) volatility of the real wage has risen. We propose an explanation for all three changes that is based on a common source: a decline in labor market frictions. We develop a simple model with labor market frictions, variable effort, and endogenous wage rigidities to illustrate the mechanisms underlying our explanation. We show that the reduction in frictions may also have contributed to the observed decline in output volatility.
It is always a challenge when stylized facts change, and here a new one is put forward. An explanation is also offered, a more flexible labor market. Both apply to the United States. Can this be generalized?