Essays in Macroeconomics of the Labor Market

Abstract

This dissertation consists of three chapters. All chapters are related to business cycle issues in the labor market with search frictions. In Chapter 1, I examine the effect of medical re-evaluations for disability insurance (DI) recipients on the 1981 recession and its fast recovery. In the US, the recovery in the employment rate of men from the 1981 recession was faster than any other recovery since 1965. During the 1981 recession and at the beginning of its recovery, the number of disability insurance applicants and recipients dropped while the numbers increased in all other recessions. This decrease is attributed to the fact that the most stringent medical re-evaluations for DI recipients occurred between 1981 and 1983. Medical re-evaluation is a policy that periodically terminates benefits of ineligible DI recipients. This paper examines the role of medical re-evaluation in the 1981 recession and its fast recovery. To this end, I build a general equilibrium business-cycle search and matching model with health, DI and unemployment insurance (UI) eligibility. Medical re-evaluations affect the number of people who search for jobs (direct effect) and job-finding probabilities for all unemployed people (general equilibrium effect). The overall effect of the policy depends on the willingness of firms to hire workers. The main experiment shows that the change in stringency of medical re-evaluations during the 1981 recession made the recession deeper and the recovery faster. In Chapter 2, my coauthor, John Seliski, and I develop a model with both frictional labor markets and financial frictions to explore how the dynamics of real and financial variables are affected by financial shocks. Financial shocks affect the borrowing capacity of firms in the economy. In particular, we evaluate how important the inclusion of financial shocks is in accounting for labor market fluctuations by using a standard RBC matching model as a benchmark. We find that the inclusion of financial frictions and financial shocks improves a standard matching model's ability to account for the observed dynamics of labor market variables. Financial frictions are able to generate more volatile hours per worker, labor shares, and employment relative to our benchmark matching model, bringing simulated moments closer to observed fluctuations. In Chapter 3, I study an alternative mechanism of wage negotiations in an environment where a firm hires more than one worker and the firm faces diminishing marginal product of labor (MPL). When Nash bargaining with a marginal worker breaks down, a firm negotiates wages with existing workers collectively and produces with them. Due to diminishing MPL, the breakdown of the negotiation with the marginal worker negatively affects the bargaining position of the firm with existing workers (one fewer workers) since MPL is higher with one fewer workers. How much the firm internalizes this negative effect depends on stochastic bargaining powers of existing workers which can be identified through labor share data. The stochastic bargaining power of existing workers provides an additional margin to increase the volatility of labor market variables. In contrast to the prediction of Rios-Rull and Santaeulalia-Llopis (2010), in which the effect of productivity shocks is dampened when labor share overshoots due to huge wealth effects from the overshooting property, this paper presents a model in which the labor share overshoots and the volatility of employment closely matches that of US data.