Essays on frictional labour markets with heterogeneous agents

The first chapter discusses the effects of uncertainty shocks on the labour market. Using US data, I show empirically that increases in unemployment are due to both an increase in the separation rate and a decrease in the job-finding rate. By contrast, standard search and matching models predict an increase in the job finding rate in response to an increase in the crosssectional dispersion of firms’ productivity levels. To explain observed responses in labour market transition rates, I develop a search and matching model in which heterogeneous firms face a decreasing returns to scale technology, firms can hire multiple workers, and job flows do not necessarily coincide with worker flows. Costly job creation is key to obtaining a decrease in the job-finding rate after an increase in uncertainty. Standard numerical solution techniques cannot be used to obtain an accurate solution efficiently and I propose an alternative algorithm to overcome this problem. The second chapter studies business cycles when markets are incomplete, nominal wages do not respond one-for-one to price level changes, and labour markets are characterized by matching frictions. During recessions, idiosyncratic labour income risk increases as workers worry about being unemployed. This induces workers to save more. We allow such precautionary savings – in principle – to end up in both an unproductive asset (money) and a productive assets (firm ownership). The increased demand for money puts deflationary pressure on prices. If nominal wages are not sufficiently responsive to deflationary pressures, wage costs and the unemployment rate are pushed up, which in turn intensifies the fear of becoming unemployed. Unemployment benefits improve welfare in our economy. The third chapter analyses the inefficiencies created in a search and matching model that allows for on-the-job search. First, the Hosios rule for the efficient level of the worker’s bargaining power is adapted in a simple model. As the average gain of a new match is lower when some job seekers already have a job, the efficient level of labour market tightness should be lower and the worker’s bargaining power higher than in a model devoid of on-the-job search. Second, the decision of when to perform on-the-job search is endogenised. Too much on-the-job search is taking place, because workers do not fully incorporate their current firms’ loss when they quit. Partial wage commitment improves the efficiency of the on-the-job search decision and the efficient level can be obtained