Lumpy Capital, Labor Market Search and Employment Dynamics over Business Cycles

This paper incorporates labor search frictions into a model with lumpy investment to explain a set of …rm-size-related facts about the United States labor market dynamics over business cycles. Contrary to the predictions of standard models, we observe that job destruction is procyclical in small …rms but countercyclical in large ones. Calibrated to U.S. data, the model generates this asymmetric pattern of employment dynamics in small versus large …rms. In the model, ex ante identical …rms face random investment opportunities. Small …rms are those that have a fewer number of workers either because they forgo investment for many periods and thus have a lower marginal labor productivity or because they fail to hire workers from a frictional labor market. If a small …rm has a low level of capital stock, it tends to make lumpy investment and grow fast. Labor market frictions in‡uence the small …rm’s investment decisions. If hiring is costly and time consuming, the small …rms may give up some investment projects which they would undertake if the labor market were Walrasian. A fovarable aggregate productivity shock tightens the labor market and makes hiring more di¢ cult. A tighter labor market hurts investing small …rms, so investment increases more in large …rms. As a result, a favorable productivity shock reallocates some workers from small to large …rms, making procyclical job destruction in small …rms possible. The paper contributes to a better understanding of …rms’interactive investment behavior and employment behavior in the presence of factor market frictions, with the resulting aggregate employment dynamics in small versus large …rms. Keywords: labor market search, lumpy capital, business cycle, job creation, job destruction JEL Classi…cation: E22 E24 E32 E37 Acknowledgement: I thank my advisors Shouyong Shi, Miquel Faig, and Diego Restuccia for guidance and suggestions. I have also bene…ted from comments and suggestions from Ruediger Bachmann, Jianfei Sun, Aloysius Siow, Aubhik Khan, Gueorgui Kambourov, Xiaodong Zhu, Elena Capatina, and seminar participants at the Univeristy of Toronto 2008, Tsinghua University 2009, the Allied Social Science Associations (ASSA) meeting 2009, the Midwest Macro Meeting (MMM) 2008, and the Canadian Economic Association (CEA) Meeting 2008. Finally, I would like to thank Julia Thomas for providing the original computational program. All errors are mine. 0