Search Frictions and Evolving Labour Market Dynamics

his paper puts Search Frictions models under novel empirical scrutiny and tests their ability to match empirical observations. To capture changing dynamics, we fit an extended Bayesian time-varying parameter VAR to US labour market data from 1962--2016. Our results show significant and important parameter change that is difficult to explain using standard theoretical models. We find that the key transmission mechanism in the Search Frictions model, a strong response of vacancies to productivity shocks, is not present in the data. This raises issues for the extensive debate on unemployment volatility. Our analysis uncovers that a shock to the cost of vacancy creation contributes substantially to the variation in labour market variables; and that these results hold for more sophisticated New Keynesian DSGE models.