Wage Rigidities, Reallocation Shocks, and Jobless Recoveries

This paper explores the joint implications of two assumptions in a business cycle model: the key shock is reallocational, rendering some of the capital stock unproductive while not affecting the remainder; and wages are rigid and do not respond to the shock. In a model with an otherwise-frictionless labor market model, an adverse shock leads to a proportional and permanent decline in capital, employment, output, consumption, and investment. In a search model with rigid wages, the impact of the shock eventually disappears but quantitatively the behavior of the economy is very similar, giving rise to a jobless recovery. ∗I am grateful for comments from Steven Davis and participants at the Econometric Society World Congress 2010, and for financial support from the National Science Foundation.