Diagnosing Labor Market Search Models: A Multiple-Shock Approach

We construct a multiple-shock version of the Mortensen-Pissarides labor market search model to investigate the basic model's well-known tendency to under predict the volatility of key labor market variables. Data on U.S. job fi nding and job separation probabilities are used to help estimate the parameters of a three-dimensional shock process comprising labor productivity, job separation, and matching or 'allocative' effi ciency. We show that the Mortensen-Pissarides labor market search model requires signifi cantly procyclical and volatile job separations to simultaneously account for high procyclical variations in jobfi nd- ing probabilities as well as relatively small net employment changes. Hence, the model is more fundamentally fl awed than its inability to amplify shocks would suggest. This leads us to conclude that the model lacks mechanisms to generate procyclical matching effi ciency and labor force reallocation. As for the latter, we conjecture that nontrivial labor force participation and job-to-job transitions are promising avenues of research.