Job Reallocation, Unemployment and Hours in a New Keynesian Model

This paper focusses on the reallocation of labour resources in a New Keynesian environment with labour market search and endogenous separations. We show that introduction of variation in hours per worker alters the incentives for intertemporal substitution in a way that generates a more steeply downward sloping Beveridge curve and reduces the tendency to synchronise gross job flows. This also enables the New Keynesian model to capture the interaction of hours and employment at business cycle frequencies. We show that the impact of labour supply elasticity on the slope of the Beveridge curve and the correlation of gross job flows is determined primarily by variation in the response to monetary shocks. When hours variation is suppressed the comovement of job creation with job destruction and of unemployment with vacancies are strongly positive in response to monetary shocks. Whereas with variation in hours both measures of reallocation take on the correct negative sign. We also note that frictions in price adjustment make it possible to account a large part of the variation in unemployment observed in US data, despite the absence of wage rigidity or departures from the Hosios condition which have been proposed to resolve the unemployment variability puzzle identified by Shimer (2005).