The consumption-tightness puzzle

Ravn, Morten O. (2007) The consumption-tightness puzzle. In, Acemoglu, Daron, Rogofff, Kenneth and Woodford, Michael (eds.) NBER Macroeconomics Annual 2006. NBER International Seminar on Macroeconomics 2006 (16/06/06 - 17/06/06) Cambridge, USA. MIT Press, 39pp.

Abstract

This paper introduces a labor force participation choice into a labor market matching model embedded in a dynamic stochastic general equilibrium set-up with production and savings. The participation choice is modelled as a tradeoff between forgoing the expected benefits of being search active and engaging in costly labor market search. The model induces a symmetry in firms’ and workers’ search decision since both sides of the labor market vary search effort at the extensive margins. We show that this set-up is of considerable analytical convenience and that it gives rise to a linear relationship between labor market tightness and the marginal utility of consumption. We refer to the latter as the “consumption - tightness puzzle” because (a) it gives rise to a number of counterfactual implications, and (b) it is a robust implication of theory. Amongst the counterfactual implications are very low volatility of tightness, procyclical unemployment, and a positively sloped Beveridge curve. These implications all derive from procyclical variations in participation rates that follow from allowing for the extensive search margin.

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