Financial Disruptions and the Cyclical Upgrading of Labor

Abstract

Amid total factor productivity (TFP) shocks job-to-job flows amplify the volatility ofunemployment, but the aggregate implications of job-to-job flows amid financial shocks are lessunderstood. To develop such understanding we model a general equilibrium labor-searchframework that incorporates on-the-job (OTJ) search and distinctly accounts for the differentialimpact of TFP and financial shocks. Surprisingly, we find that the interaction of OTJ search withfinancial shocks is sufficiently different from its interaction with TFP shocks so that, understandard calibrations, our model generates aggregate dynamics exceedingly in line with thebehavior of key U.S. macro data across several decades and in the wake of the Global FinancialCrisis as well. Importantly, as in the data, the model yields relatively high volatilities ofconsumption, labor income, and unemployment. As such, our work contributes to resolving twolimitations of current general equilibrium labor-search theory: under standard calibrations modelswithout OTJ search generate implausibly low unemployment volatility, while models with OTJsearch generate unemployment volatility closer to the data but at the expense of implausibly lowconsumption and labor-income volatility.

Keywords: Business cycles, financial frictions, labor search frictions, on-the-job search, Financial Markets and the Macroeconomy

JEL Classification: E24, E32, E44