Mehrab Kiarsi - Business Cycle Properties of Macro Variables in a Standard New-Keynesian Model with Unemployment

Date and Time: November 5th, 2018, 2:30 - 4:00 pm

Room: Meeting Room, 1st floor, Dongliuzhai (Old Campus)



I show that, under common parameter values, a standard New-Keynesian model with standard search and matching frictions and Nash bargaining accounts significantly well for almost all key business cycle properties of the relevant U.S. macroeconomic variables, including relative standard deviations, autocorrelations, and correlations with output. In addition to its ability to explain the dynamics of inflation and persistent effects of monetary shocks, the model can produce exact cross correlations of the three central aggregate labor variables-unemployment, labor market tightness, and vacancies- as seen in the data. What accounts most for the success of the model is a low value for vacancy costs to GDP ratio, that is equivalent to having a high value for what Ljungqvist and Sargent (AER, 2017) call the inverse of the fundamental surplus fraction, and is inextricable from it. However, in contrast to what Ljungqvist and Sargent suggest that the fundamental surplus fraction is the single intermediate channel through which economic forces generating a high elasticity of market tightness with respect to productivity, I show that the fundamental surplus fraction (or the vacancy cost-GDP ratio) can be at their lowest possible values in the steady state, but the model doesn't generate enough volatility in unemployment if the steady state rate of unemployment is very high. Another contribution of the paper is to demonstrate that how wage inertia emerges as an internal feature of the standard matching model (due to the free-entry condition in vacancy creation) if one wants to have high volatility in unemployment. In other words, due to the nature of the model, there is a trade-off between wage volatility and unemployment volatility. However, this trade-off doesn't necessary emerge in the presence of a labor tax.

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