New Keynesian Labor-Market Model in 673 Words

Print/Save PDF

In Job Matching, Wage Dispersion, and Unemployment (2011) Tatsiramos and Zimmermann, hereafter T&Z, provide a compact summary of mainstream New Keynesian (NK) modeling of labor behavior in modern highly specialized economies. What follows describes that market-centric search/match theory which fundamentally shapes the usefulness of macroeconomics today.

“The flow view of the labor market is fundamental in the theory of equilibrium unemployment, as expressed in Pissarides (2000). Unemployment is a state which individual workers occupy for a relatively short period of time, as they seek rewarding long-term employment. Individual workers flow into the state and others flow out. Offsetting the flow of job finders and unemployed workers who have given up job search to take up leisure or other activities outside the labor force, is a simultaneous flow into the state of unemployment of workers who lost their jobs either through layoff of quit, and new entrants from a nonparticipation state.

“This conception of the labor market has replaced the disequilibrium theory under which employment was determined by the real wage and labor demand, and unemployment simply reflected excess supply at a real wage that was above that required to clear the labor market. The disequilibrium theory, which viewed the labor market as a spot market that meets every day to allocate jobs to workers, was inconsistent with the observations regarding the experience of individual workers over time; in particular, the fact that that a small fraction of the labor force flow in and out of unemployment each year and the typical employment relationship lasts several years. Furthermore, available jobs are heterogeneous, offering different wages, differing long-term career opportunities, and various kinds of non-pecuniary features, such as job security. These facts suggest that workers might find it in their interest to invest time and effort in the process of finding a ‘good” job, one that pays well, that might offer a challenge, good promotion prospects and consequently have a chance of lasting for a while….

“If the worker is already in a job and has the option of staying on, quitting into unemployment poses a problem that is very similar to the acceptance problem of the unemployed job seeker. The existing job is an implicit offer on the table to continue employment, the quitting alternative is a search option for an uncertain outcome. Even for jobs that have become less profitable than when they were first opened, there is a nontrivial choice to be made between continuing employment or leaving the job and seeking new job offers.

“A similar choice is faced by the firm. Should it close down jobs that have become less profitable or continue production? A large part of entry into unemployment is the result of job closure but this job closure is not necessarily the result of shocks that make the job’s overall profits negative instantly and forever. Just as there are reservation wages for unemployed workers looking for job offers, there are reservation productivities for employed workers and their firms….

“This view of the labor market formed the basis of a coherent theory of worker and employer behavior in a market in which trading opportunities are generated through search and jobs are subject to change. The theory is based on solid maximizing microfoundations under rational expectations about the future, when all gains from private trades are exploited within the constraints imposed by the market information structure.”

That’s it. A hard fact has become pretty obvious. Mainstream economists are fooling themselves that instability in modern, highly specialized economies can be adequately understood through the lens of search-match modeling which used to be confined to explaining frictional joblessness. Non-economists observers balk at the incompleteness of that market-centric story. Is labor activity inside the firm truly irrelevant? Isn’t on-the-job behavior at least as important as searching for and acquiring employment. The significance of  OJB governance is a clear message of the role human-resource departments always play in large, complex firms. For starters, relatively little attention is paid to recruitment. Next week’s post looks at the debilitating effects of NK convenient S/M modeling.

Blog Type: New Keynesians

Write a Comment

Your email address will not be published.