Discussion Paper Details

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Title: The Hiring Frictions and Price Frictions Nexus in Business Cycle Models

Author(s): Renato Faccini and Eran Yashiv

Publication Date: November 2016

Keyword(s): Business Cycles, Diamond, endogenous wage rigidity, hiring frictions, monetary policy shocks, Mortensen and Pissarides (DMP) model, New Classical model, New- Keynesian model, price frictions and technology shocks

Programme Area(s): Labour Economics and Monetary Economics and Fluctuations

Abstract: We study the interactions between hiring frictions and price frictions in business cycle models. We find that these interactions matter in a significant way for business cycle fluctuations and for labor market outcomes. Using a simple DSGE business-cycle model with Diamond-Mortensen-Pisssarides (DMP) elements, we derive two main results. First, introducing hiring frictions into a New Keynesian model offsets the effects of price frictions. As a result, some business cycle outcomes are actually close to the frictionless New Classical-type outcomes; namely, with moderate hiring frictions the response of employment to technology shocks is positive, and the effects of monetary policy shocks are small, if not neutral. Moreover, it generates endogenous wage rigidity. Second, introducing price frictions into a DMP setting generates amplification of employment and unemployment responses to technology shocks, as well as hump-shaped dynamics. Both results arise through the confluence of frictions. We offer an explanation of the mechanisms underlying them.

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Bibliographic Reference

Faccini, R and Yashiv, E. 2016. 'The Hiring Frictions and Price Frictions Nexus in Business Cycle Models'. London, Centre for Economic Policy Research.