Academic journal article Economic Perspectives

Evaluating the Role of Labor Market Mismatch in Rising Unemployment

Academic journal article Economic Perspectives

Evaluating the Role of Labor Market Mismatch in Rising Unemployment

Article excerpt

Introduction and summary

From the second half of 2009 through the end of 2010, the U.S. labor market witnessed a systematic increase in the rate of job openings while the unemployment rate remained essentially unchanged. Some have argued that, evidently, the problem in the labor market during this period was not that firms were reluctant to hire additional workers, but that, for whatever reason, firms seemed unable to find suitable workers to staff the positions they were trying to fill. By this logic, using monetary policy to encourage further hiring by firms would have been unlikely to drive down unemployment: If firms were already trying to hire but could not, why should policy actions that mainly serve to encourage even more hiring have any impact on unemployment? The unemployment rate did finally register a decline in late 2010 and early 2011--a development that may eventually render less acute the debate about the need for monetary policy to address the problem of high unemployment. Still, constructing a framework for interpreting such labor market patterns and their policy implications remains an important goal. This is especially true given that there have been other periods in which job vacancy rates seemed to rise without a commensurately large fall in unemployment, although those episodes were not as dramatic nor as long as the most recent one.

In this article, I show how the labor market matching function approach developed by Pissarides (1985) and Mortensen and Pissarides (1994) can be used to assess the validity of the proposition that recent trends in vacancies and unemployment necessarily point to a diminished role for monetary policy. More specifically, I show that this framework indeed suggests that an increase in unemployment without a commensurate decline in vacancies can be indicative of a labor market shock that monetary policy cannot offset. However, this framework can also be used to derive a bound on how much a shock of this type can affect unemployment. Applying these insights to the period of the Great Recession reveals that this type of shock by itself would lead to an unemployment rate of 7.1 percent, considerably lower than the unemployment rate during most of this period. The higher actual unemployment rate suggests that other types of shocks, which monetary policy may be able to address, must also be operating. Hence, the recent patterns in unemployment and vacancy data do not necessarily rule out an important role for monetary policy. Whether more expansionary monetary policy would have been beneficial is a question that is beyond the scope of this article. Nevertheless, the matching function approach frames this question in a potentially useful way--that is, as a question of why the value of taking on additional workers appears to be so much lower now than in normal economic times.

My article is organized as follows. I begin by describing the matching function approach, and then I show that the shocks that affect unemployment in this framework can be decomposed into two groups--those that affect the ability of firms to find and hire qualified workers and those that affect the value to a firm of taking on an additional worker. I next explain how the model can be used to predict how a shock to the ability of firms to hire, calibrated to match the facts on unemployment and vacancies during the Great Recession, affects unemployment. Using this result, I argue that the increase in unemployment due to this shock is much smaller than the actual increase in unemployment during this period, so a shock to the ability of firms to hire cannot by itself account for the rise in unemployment during this time. I conclude with a discussion about how measurement issues are likely to affect these conclusions.

The matching function approach

In this section, I lay out the key features of the labor market matching framework developed in Pissarides (1985) and Mortensen and Pissarides (1994). …

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