Persistence, Propagation and On-the-Job Search

Standard business cycle models often have difficulty matching salient stylized facts such as hump-shaped responses to shocks or persistence. This is mainly due to the lack of a strong endogenous propagation mechanism. In this paper we demonstrate that a real business cycle with a labor market characterised by search and matching and, crucially, on-the-job search can resolve these shortcomings. We show that on-the-job search is a key component in explaining labor market dynamics in models of equilibrium unemployment. The model predicts fluctuations of unemployment, vacancies, and labor productivity whose relative magnitudes replicate the data. Moreover, the interaction between on-the-job search and job creation also generates a strong internal propagation mechanism that leads endogenously to a hump-shaped response of output to technology shocks. The model can replicate the business cycle facts without the high degree of exogenous persistence required in standard models