By Melvyn Coles and Ali Moghaddasi Kelishomi
The current DMP approach to labor markets presumes job destruction shocks are small. We relax that assumption and also allow unfilled jobs, like unemployment, to evolve as a state variable. Calibrating an otherwise standard DMP framework, we identify a remarkable, (almost) perfect, fit of the empirical facts as reported in Shimer (2005, 2012). The results, how- ever, are also consistent with the insights of Davis and Haltiwanger (1992): that unemployment volatility is driven by large but infrequent job separation shocks. The approach not only provides an important synthesis of two literatures which, in other contexts, have appeared contradictory, it also identifies a more traditional view of the timing and progression of recessions.
I find it quite amazing how the Diamond-Mortensen-Pissarides model keeps on giving. Here is a variation that successfully tackles the Shimer (2005) puzzles that once gave DMP much trouble. Several solutions have been offered, and I find this one quite convincing.