Working Paper: NBER ID: w12421
Authors: Morten O. Ravn
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.
Keywords: Labor Market; Participation Choice; Consumption; Tightness Puzzle
JEL Codes: E24; E32; J20; J41; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| labor market participation choice (J29) | linear relationship between labor market tightness and marginal utility of consumption (J20) |
| increased vacancies (J63) | higher labor market participation (J49) |
| higher labor market participation (J49) | affects unemployment rates (J64) |
| procyclical variations in labor market participation rates (J29) | low volatility of labor market tightness (J69) |
| model predictions (C59) | unrealistically high degrees of risk aversion and low intertemporal elasticity of substitution (D11) |