Macroeconomic Policy and Labor Markets: Lessons from Dale Mortensen's Research

By Benson, David | Chicago Fed Letter, August 2011 | Go to article overview

Macroeconomic Policy and Labor Markets: Lessons from Dale Mortensen's Research


Benson, David, Chicago Fed Letter


On April 15-16, 2011, Northwestern University and the Chicago Fed co-sponsored a conference in honor of Dale Mortensen ? a Northwestern University professor, Chicago Fed consultant, and co-recipient (along with Peter Diamond and Christopher Pissarides) of the 2010 Nobel Prize in economics, awarded for his analysis of markets with search frictions. This article summarizes one panel that presented work on the current state of the U.S. labor market, using Mortensen's research.

The panel featured Gadi Barlevy, Federal Reserve Bank of Chicago; David Andolfatto, Federal Reserve Bank of St. Louis; Lawrence Christiano, Northwestern University; Robert Hall, Stanford University; and Gianluca Violante, New York University.1 The panelists discussed how Mortensen's work provides a useful framework for interpreting recent labor market developments (e.g., sustained high unemployment) . The Diamond-Mortensen-Pissarides framework predicts a downward sloping relationship between unemployment and job vacancies - what economists call a "Beveridge curve." Most of the time, and certainly before the Great Recession,2 the job vacancy rate (the number of unfilled jobs divided by the labor force) is negatively related to the unemployment rate (see figure 1). The panel focused on the fact that from 2009: Q2 through much of 2010, job vacancies rose while unemployment remained virtually unchanged, suggesting a shift in the Beveridge curve. The difference between the black data (pre-shift) and red data (post-shift) in figure 1 illustrates this. The panelists debated whether and how the underlying parameters that affect the Beveridge curve might have changed, and they discussed whether the changes are a sign of a "structural shift" - e.g., a shock that makes it harder for firms to find workers who possess the skills for the types of jobs firms are seeking to staff. The panelists also discussed the role of monetary policy in addressing the high rate of unemployment in light of the apparent shift of the Beveridge curve.

The value of a filled job

In his presentation, Barlevy argued that two types of shocks can affect the unemployment rate in a typical Mortensen-style model: a shock to the ability of firms to find workers (or labor market mismatch) and a shock to the profitability of filling any given job vacancy for firms.3 He argued that monetary policy can do little to address labor market mismatch. Barlevy then showed how the same model can be used to calculate a bound on how much a shock to firms' hiring ability affects unemployment.

Assuming an initial unemployment rate of 5%, he argued that a hiring shock alone would have raised the unemployment rate by at most 2.1 percentage points. This shock can thus account for no more than 40% of the total increase in the unemployment rate in the recent data - from 5% to 10.1%. Barlevy concluded that the other source of shocks in the model, the value of filling a job vacancy for firms, must have fallen relative to normal times to account for the high rate of unemployment. Unlike an increase in mismatch, a fall in the value of a filled job for employers may justify more accommodation from monetary policymakers. However, Barlevy cautioned that to make the case for a more aggressive policy response, one must understand why filling job vacancies now appears less valuable.

Structural shocks

Andolfatto argued the recent data may be consistent with structural shifts playing a larger role in contributing to high unemployment. He noted that since work by Abraham and Katz4 the telltale sign of a structural shock for economists has been a positive co-movement in unemployment and job vacancies (i.e., the unemployment and job vacancy rates increasing in tandem). But Andolfatto argued that a structural shock may appear not as a positive co-movement of the two, but as a Beveridge curve that appears flatter than in the past.

In particular, Andolfatto simulated structural shocks in a model economy developed by Mortensen. …

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