Discussion paper

DP11639 The Hiring Frictions and Price Frictions Nexus in Business Cycle Models

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
Both results arise through the confluence of frictions. We offer an explanation of the
mechanisms underlying them.


Yashiv, E and R Faccini (2016), ‘DP11639 The Hiring Frictions and Price Frictions Nexus in Business Cycle Models‘, CEPR Discussion Paper No. 11639. CEPR Press, Paris & London. https://cepr.org/publications/dp11639