Labor Market Dynamics: A Time‐Varying Analysis

Date01 June 2015
Published date01 June 2015
DOIhttp://doi.org/10.1111/obes.12096
319
©2015 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 0305–9049
doi: 10.1111/obes.12096
Labor Market Dynamics:A Time-Varying
Analysis*
Haroon Mumtaz, Francesco Zanetti
Queen Mary University,Mile End Road, London, E1 4NS, UK
(e-mail:h.mumtaz@qmul.ac.uk)
Department of Economics, University of Oxford, Manor Road Oxford, OX1 3UQ, UK
(e-mail: francesco.zanetti@economics.ox.ac.uk)
Abstract
This paper studies how key labour market stylized facts and the responses of labour market
variables to technology shocks vary over the US postwar period. It uses a benchmark
dynamic, stochastic, general equilibrium model enriched with labour market frictions and
investment-specific technologicalprogress that enables a novel identification scheme based
on sign restrictions on a SVAR with time-varying coefficients and stochastic volatility. Key
findings are: (i) the volatility in job finding and separation rates has declined over time,
while their correlation varies across time; (ii) the job finding rate plays an important role
for unemployment, and the two series are strongly negatively correlated over the sample
period; (iii) the magnitude of the response of labour market variables to technology shocks
varies across the sample period.
I. Introduction
The dynamics of the labour market have been a subject of intense empirical and theoretical
research over the past three decades. This paper contributes to this realm of research by
studying how the statistical relation among keylabour market aggregates and their response
to technology shocks change over the US postwar period. To this aim, it develops an
estimated time-varying parameter vector autoregression (TVP-VAR) model with stochastic
volatility, whose variables’ reaction to technology shocks is identified using the cyclical
properties of a dynamic, stochastic, general equilibrium (DSGE) model of the business
cycle characterized by labour market frictions.
We use a model with labour market frictions to investigate the dynamics of the labour
market due to their empirical relevance and theoretical appeal. Empirically, Rogerson
and Shimer (2011) summarize evidence showing that labour markets are characterized by
JEL Classification numbers: E32, C32.
*We wouldlike to thank Anindya Banerjee and three anonymous referees for extremely helpful suggestions and
Sophocles Mavroeidis, Lydia Silver and seminar participants at the Bank of England and the Universityof Oxford
for very useful comments.
320 Bulletin
frictions that prevent the competitive market mechanism from determining labour market
equilibrium allocations, thereby suggesting that their presence is important for a realistic
description of the functioning of the labour market. Theoretically, labour market frictions
introduce the extensive margin of labour (i.e. (un)employment) into the model, whose
dynamics depend on the flows of workers in and out of unemployment. Importantly for the
analysis of the paper, we make the rate at which jobs are destroyed endogenous, so that
flows in and out of unemployment result from the incentives that workers and firms have
to engage in production or terminate their relation. In this way, the theoretical framework
details the dynamics of unemployment, job finding and job separation rates, whosereaction
to shocks enables a new identification scheme.
The analysis establishes important stylized facts of the US labour market. In particular,
it uncovers the following findings:
(i) The volatility of job finding and job separation rates declines over the sample pe-
riod, after reaching a peak around the mid-1980s. However, changes in the volatil-
ity of the job finding and job separation rates display different patterns over sub-
periods.
(ii) The cor relation of the labour market variables with GDP growth is relatively stable
over time, whereas the correlation between the job finding and job separation rates and
the unemployment rate shows significant time variation. In particular, the job finding
rate plays an important role for the unemployment rate, and the two series are strongly
negatively correlated over the sample period.
(iii) The magnitude of the response of labour market variables to neutral technology shocks
varies over time, whereas the response to investment-specific technology shocks is
substantially constant. Neutral technology shocks decrease unemployment.
(iv) Across the sample period, neutral technology shocks explain approximately half of
the movements in unemployment and the job finding rate, whereas they explain only
20% of fluctuations in the job separation rate. Investment-specific technology shocks
contribute to, on average, 20% of fluctuations in unemployment, job finding and job
separation rates.
(v) The time-varying trends of the job separation rate and the unemployment rate show a
similar pattern, and they peak in the early 1980s.
The contribution of this paper is threefold. First, to the best of our knowledge no papers
have yet investigated how the statistical relation among key labour market variables and
their response to technology shocks changes over time. A few studies, detailed below,
investigate the time-varying response of macroeconomic variables to shocks, but none of
them focuses on the dynamics of the labour market.
Second, the theoretical framework embeds endogenous job destruction in a model
in which technology shocks are distinguished between neutral and investment-specific
technological processes, since the latter are key to study the dynamics of the technolog-
ical progress, as shown in Greenwood, Hercowitz and Krusell (1997), Fisher (2006) and
Justiniano and Michelacci (2011). Therefore, the model provides new insights into the
time-varying effect of investment-specific technology shocks on labour market variables,
and, importantly for our analysis, enables a novel identification scheme.
©2015 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd

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