Labor market frictions and the propagation of business cycle shocks

This dissertation investigates the ability of labor market frictions to explain why economic fluctuations are so persistent. Matching models of the type associated with Diamond, Mortensen, and Pissarides explicitly account for the difficult and time-consuming nature of job search and thus provide a natural framework for analyzing employment fluctuations. Chapter 1 of this dissertation examines the accomplishments of this literature and shows that standard matching models fail to generate a realistic amount of unemployment rate persistence when forced to account for evidence that on average unemployed workers find new jobs relatively quickly.;Chapter 2 presents a matching model that can explain the persistence of employment fluctuations by accounting for the recurring job loss that workers often experience following an initial displacement. In the model, the search process weeds out bad worker-firm matches imperfectly so that a worker and firm must form an employment relationship and observe its productivity over time in order to learn its true quality. As a result of the learning process, employment relationships exhibit hazard rates that decline with tenure and consequently displaced workers may experience several short-lived jobs before settling into stable employment. At an aggregate level, a jump in the unemployment rate that results from an adverse shock to the economy leaves in its wake a sustained flow of recurring job loss. Thus, the unemployment rate slowly falls back to normal levels. Simulations of the model demonstrate that accounting for workers' recurring job loss generates realistic levels of unemployment rate persistence despite high job-finding rates.;Chapter 3 introduces a related model to identify which driving forces are most likely to translate recurring job loss into persistent employment fluctuations. Simulations reveal that traditional aggregate shocks---those that affect the productivity of all worker-firm matches---result in less persistent fluctuations than reallocative shocks---those that render unprofitable only a portion of all matches, without affecting the productivity of others. The reason is that reallocative shocks bring about a larger increase in the aggregate separation rate by causing a greater shift in the distribution of workers toward more vulnerable matches.