New Keynesian perspectives on labor market dynamics$

We find that demand shocks play an important role for business-cycle fluctuations in unemployment and job vacancies. The reason is that those shocks give a strong incentive to demand-constrained firms to adjust production and thereby labor input. Furthermore we argue that whether real wage rigidity a` la Hall [2005. Employment fluctuations with equilibrium wage stickiness. American Economic Review 95, 50–65] helps explain the remaining part of the unemployment volatility puzzle depends critically on assumptions regarding the form of the wage bargain between firms and workers. Real wage rigidity tends to generate volatility in employment only in the case in which hours are chosen efficiently. If, on the other hand, the real wage is allowed to affect firms’s choices of hours directly, the feature of real wage rigidity loses its ability to increase employment volatility