Frictional Unemployment with Stochastic Bubbles

75 Pages Posted: 10 Oct 2016

See all articles by Guillaume Vuillemey

Guillaume Vuillemey

HEC Paris - Finance Department

Etienne Wasmer

New York University (NYU) - New York University Abu Dhabi; Centre for Economic Policy Research (CEPR)

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Abstract

Bubbles are recurrent events, which contribute to both macroeconomic and employment volatility. We introduce stochastic bubbles in the standard search-and matching model of the labor market. The economy alternates between latent and bubbly states, each being associated with a distinct solution for the market value of firms (respectively, stable or explosive). Bubbles in firm value induce distortions in hiring decisions and wages, which we explicitly characterize. Faced with bubbles, the social planner optimally deviates from the standard Hosios efficiency condition. The optimal share of workers in total surplus must be above the elasticity of hiring rates, by a small but increasing amount as the bubble expands. Finally, our specification for bubbles significantly improves the quantitative ability of the model to match U.S. data, along both real and financial dimensions.

Keywords: unemployment volatility, labor frictions, bubbles

JEL Classification: E32, J60

Suggested Citation

Vuillemey, Guillaume and Wasmer, Etienne, Frictional Unemployment with Stochastic Bubbles. IZA Discussion Paper No. 10265, Available at SSRN: https://ssrn.com/abstract=2849750

Guillaume Vuillemey (Contact Author)

HEC Paris - Finance Department ( email )

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France
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HOME PAGE: http://sites.google.com/site/guillaumevuillemey/home

Etienne Wasmer

New York University (NYU) - New York University Abu Dhabi ( email )

PO Box 129188
Abu Dhabi
United Arab Emirates

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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