EndogenousSeparation,WageRigidityandthe-Brandeis.PDF

Endogenous Separation, Wage Rigidity and the Dynamics of Unemployment Daniel L. Tortoricey Brandeis University September 2010 Abstract This paper shows that the Mortensen-Pissarides (MP) model requires endogenous separation to explain the volatility of unemployment. I estimate a version of the MP model with wage rigidity and permanent shocks to match productivity. The model gen- erates su¢ cient volatility in unemployment, vacancies, job-Önding and job-separation despite relatively low worker outside options. I then re-estimate the model while re- stricting the separation rate to be constant and show that, even though the estimation procedure Önds the best Ötting model, the model predicts too little variance in unem- ployment and too much variance in the job-Önding rate. Based on this result I conclude that models of unemployment áuctuations need endogenous separation rates to explain unemployment áuctuations. Keywords: Unemployment, Search Models, Business Cycles JEL Codes: J64, E24, E32 I thank David Laibson, N. Gregory Mankiw, and James Stock for advising me on this project. I also thank Bruce Fallick, Andrew Figura, Kirk Moore, Gauri Kartini Shastry and participants in seminars at Harvard University, Brandeis University, the Federal Deposit Insurance Corporation, The Federal Reserve Board of Governors and the University of Notre Dame for helpful comments and suggestions. I thank Harvard University and the United States Department of Education, Jacob K. Javits Fellowship Program for supporting my graduate education. All mistakes are mine.