Business Cycles with Costly Search and Recruiting.

A business-cycle model is developed in which output is traded on Lucas-Phelps islands and labo r services on each island are exchanged through costly search and rec ruiting with transactions externalities. The model exhibits persisten t involuntary unemployment and inefficient equilibria, even though th ere are no nominal rigidities and no unexploited privately attainable gains from trade. It also exhibits employment fluctuations without a ny real-wage fluctuations. It yields a Lucas aggregate supply curve ( to a linear approximation). It also implies that the natural rate of unemployment depends positively upon the variability and persistence of relative price shocks. Copyright 1988, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.