Amplification of Productivity Shocks: Why Vacancies Don’t Like to Hire the Unemployed?

In this paper I study a new amplification mechanism in search models that arises when workers can choose to search on the job and, despite the fact that all workers are ex-ante identical, employers prefer to hire already employed workers for endogenous reasons. The motivation for on-the-job search in the model is job-shopping, where workers look for jobs they find appealing, and the appeal of a job to the worker is not observed by the firm. In equilibrium, workers arriving from unemployment are more likely to leave a job for a more appealing job, and, knowing this, firms prefer to hire already employed, as opposed to unemployed, workers. Employers’ preference for hiring already employed workers introduces a new amplification mechanism into search models. This is because vacancies in the model with such preference respond more to aggregate shocks than in the standard search model due to the fact that employed workers reduce their search intensity in a recession, thereby making it less attractive for firms to post vacancies. Using simulations of the proposed model, I explore the extent that the presence of job-to-job transitions can help in explaining the volatility of unemployment and vacancies over the business cycle through this new amplification mechanism. The simulation results show that, for standard parameter values, this new mechanism can generate five times more amplification compared to the baseline model. This paper was previously titled “Worker Reallocation over the Business Cycle: The Importance of Job-to-Job Transitions, Part 2: Theory”. Department of Economics, Northwestern University, 2001 Sheridan Road, Evanston, IL 60208-2600, USA. E-mail: [email protected]