Matching frictions, unemployment dynamics and the cost of business cycles

By Jean-Olivier Hairault, François Langot and Sophie Osotimehin

http://d.repec.org/n?u=RePEc:hal:cesptp:hal-00516832_v1&r=dge

We investigate the welfare cost of business cycles implied by matching frictions. First, using the reduced-form of the matching model, we show that job finding rate fluctuations generate intrinsically a non-linear effect on unemployment: positive shocks reduce unemployment less than negative shocks increase it. For the observed process of the job finding rate in the US economy, this intrinsic asymmetry increases average unemployment, which leads to substantial business cycles costs. Moreover, the structural matching model embeds other non-linearities, which alter the average job finding rate and consequently the welfare cost of business cycles. Our theory suggests to subsidizing employment in order to dampen the impact of the job finding rate fluctuations on welfare.

There has been some talk, but not much, about subsidizing new hires in the US, but the focus seems to be more on Keynesian measures. Is this paper a good way of understanding why unemployment is currently so high, and what could be done about it? There is certainly mounting evidence that sectoral and geographical frictions on the labor market are important, but this has not always been so, especially compared to Europe.

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