The labour market over the business cycle: can theory fit the facts?

Abstract

We examine the ability of six labour market models to account for the business cycle behaviour of UK labour markets when embedded in a stochastic growth model. WE assess the models in terms of : (i) their ability to mimic general business cycle correlations and volatility (ii) their success at explaining the persistence of labour market fluctuations and (iii) whether the models can explain why the growth and speed of adjustment of labour market variables changes between periods of expansions and contractions. The main success of the models is the ability to broadly account for business cycle correlations and co-movements and the changes in employment/unemployment growth rates between expansions and contractions. However, there are three main failures (a) the models tend to produce insufficiently volatile employment and unemployment fluctuations (b) the models tend to produce too strong a correlation between wages and employment (c) most of the models generate only brief temporary deviations in unemployment in response to shocks rather than the protracted dynamics of the data