Equilibrium business cycles and the labor market

Since the end of World War Two, the US unemployment rate has remained constant while the EU unemployment rate started to increase at the beginning of the 1970s. This increase in aggregate unemployment hides dramatic differences across skill groups: the increase has remained fairly small for high-skilled workers, while it is usually considerable for the least skilled workers. What caused these developments still remains a debated issue. A possible explanation is the size of the labor market institutions, much more developed on this side of the Atlantic. To study this question, we construct an intertemporal general equilibrium model. We start from the standard Real Business Cycle (RBC) model and we extend it by adding labor market frictions and institutions (minimum wage, employment protection and unemployment benefits). We also further develop the model along the skill dimension, by assuming that the population is composed of low- and high-skilled workers. The main conclusion is that rigid institutions, and especially rigid wages, may well play an important role, direct or indirect through the interactions with exogenous shocks, to explain the relative rise in the European unemployment rate, and especially the low-skilled unemployment rate. We also show that reductions in employer's contributions, targeted at the minimum wage, lead to a fall in the destruction of the less productive jobs and therefore strongly stimulate low-skilled employment, while increasing the welfare of all individuals.(ECON 3)--UCL, 200