Two papers on frictions in the business cycle

The last NEP-DGE report has two very interesting papers on frictions in the business cycle. I could not bring myself to feature only, so here are both. The first is interesting in that it can account for the movement of both the size and quantity of asset liquidity in the market through a cycle, the second in that it shows that the costless vacancy creation hypothesis in a typical labor search model has important implications, especially if you want to account for long recoveries.

Search-based endogenous asset liquidity and the macroeconomy

By Wei Cui and Sören Radde

http://d.repec.org/n?u=RePEc:ecb:ecbwps:20161917&r=dge

We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors’ participation on the search market. Limited market liquidity of private claims creates a role for liquid assets, such as government bonds or at money, to ease financing constraints. We show that endogenising liquidity is essential to generate positive comovement between asset (re)saleability and asset prices. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, investment falls while the hedging value of liquid assets increases, driving up liquidity premia. Our model, thus, demonstrates that shocks to the cost of financial intermediation can be an important source of flight-to-liquidity dynamics and macroeconomic fluctuations, matching key business cycle characteristics of the U.S. economy.

The slow job recovery in a macro model of search and recruiting intensity

By Sylvain Leduc and Zheng Liu

http://d.repec.org/n?u=RePEc:fip:fedfwp:2016-09&r=dge

Despite steady declines in the unemployment rate and increases in the job openings rate after the Great Recession, the hiring rate in the United States has lagged behind. Significant gaps remain between the actual job filling and finding rates and those predicted from the standard labor search model. To examine the forces behind the slow job recovery, we generalize the standard model to incorporate endogenous variations in search intensity and recruiting intensity. Our model features a vacancy creation cost, which implies that firms rely on variations in both the number of vacancies and recruiting intensity to respond to aggregate shocks, in contrast to the textbook model with costless vacancy creation and thus constant recruiting intensity. Cyclical variations in search and recruiting intensity drive a wedge into the matching function even absent exogenous changes in match efficiency. Our estimated model suggests that fluctuations in search and recruiting intensity help substantially bridge the gap between the actual and model-predicted job filling and finding rates in the aftermath of the Great Recession.

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