2011: Optimal Labor-Market Policy in Recessions (with Keith Kuester)
We examine the optimal labor market-policy mix over the business cycle. In a search and matching model with risk-averse workers, endogenous hiring and separation, and unobservable search effort we first show how to decentralize the constrained-efficient allocation. This can be achieved by a combination of a production tax and three labor-market policy instruments, namely, a vacancy subsidy, a layoff tax and unemployment benefits. We derive analytical expressions for the optimal setting of each of these for the steady state and for the business cycle. Our propositions suggest that hiring subsidies, layoff taxes and the replacement rate of unemployment insurance should all rise in recessions. We find this confirmed in a calibration targeted to the U.S. economy.
2011:The (Un)importance of Unemployment Fluctuations for Welfare
(with Keith Kuester) , forthcoming in: JEDC
This paper studies the cost of business cycles within a real business cycle model with search and
matching frictions in the labor market. We endogenously link both the cyclical fluctuations and
the mean level of unemployment to the aggregate business cycle risk. The key result of the paper
is that business cycles are costly: Fluctuations over the cycle induce a higher average unemployment
rate since employment is non-linear in the job-finding rate and the past unemployment
rate. We show this analytically for a special case of the model. We then calibrate the model to
U.S. data. For the calibrated model, too, business cycles cause higher average unemployment;
the welfare cost of business cycles can easily be an order of magnitude larger than Lucas’ (1987)
estimate. The cost of business cycles is the higher the lower the value of non-employment, or,
respectively, the lower the disutility of work. The ensuing cost of business cycles rises further
when workers’ skills depreciate during unemployment.
http://dx.doi.org/10.1016/j.jedc.2011.05.008
2011: The Era of the U.S.-Europe Labor Market Divide: What can we learn? (with Moritz Kuhn)
(an earlier working paper version was entiteld: Business cycle volatiltiy
and Labor market rigidit)
Rigid labor markets are characterized by low average hiring and firing rates. We show that these rigidities simultaneously induce a large volatility in the firing rate, a more volatile unemployment rate, and, ultimately, an increased vulnerability of the economy to business cycle shocks. Empirically we document that compared to the U.S. average hiring rates in Germany are a quarter the size while the firing rate volatility is 2.5 times larger. Firings contribute to $70\%$ of the aggregate unemployment volatility in Germany while in the U.S. hirings explain the bulk of the unemployment volatility. We show that neither wage rigidities nor employment protection legislation explain these large differences. Based on a search and matching framework featuring endogenous firings and efficient bargaining we argue theoretically that our findings are to be expected. Our model is well able to reproduce the time series pattern of labor market variables for both countries. The highlighted mechanism leads to a substantial amplification and propagation effect of business cycle shocks.
2009: Has the Euro changed the Business Cycle?
(with Zeno Enders and Gernot Mueller)
In this paper we analyze European business cycles before and under EMU. Across the two
periods we find 1) a significant decline in real exchange rate volatility, 2) significant changes
in cross-country correlations, and 3) the volatility of macroeconomic fundamentals largely unchanged. We develop a two-country business cycle model and show that the calibrated model is able to replicate key features of the data prior to and under EMU.We find that the euro has a stron bearing on the transmission mechanism as cross-country spillovers increase substantially under EMU. As a result, foreign shocks become more and domestic shocks less important in accounting for the (unchanged) volatility of macroeconomic fundamentals.