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Reconciling the Relevance of Labor Market Institutions in Search and Matching Models with International Evidence

Wataru Hirata

No 12-E-2, Bank of Japan Working Paper Series from Bank of Japan

Abstract: This paper examines whether search and matching frictions in labor markets can account for cross-country differences in business cycle properties. The particular interest is the joint effect of two institutional variables, employment protection and the replacement income of unemployed workers. I first document an empirical regularity that higher degrees of employment protection and/or lower replacement rates are associated with larger standard deviations of real wages relative to those of unemployment in OECD members. However, there is a positive correlation between employment protection and replacement rates implying that the net effect of the systematic difference in these institutional variables could be ambiguous. I then show that modern macroeconomic models with search and matching frictions are broadly consistent with the stylized fact: the models predict that higher firing costs and/or lower replacement rates raise the wage volatility relative to that of unemployment. I find that this result is robust to alternative setups of non-labor markets. Finally, I find that the effect of the above institutions on inflation is minor.

Keywords: search and matching frictions; labor market institutions; cyclicalities; real wage; unemployment (search for similar items in EconPapers)
JEL-codes: E24 E31 E32 J63 J64 J88 (search for similar items in EconPapers)
Date: 2012-02-20
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Handle: RePEc:boj:bojwps:12-e-2