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Firm Dynamics, On-The-Job Search and Labor Market Fluctuations

Firm Dynamics, On-The-Job Search and Labor Market Fluctuations

By Mike Elsby and Axel Gottfries

Abstract

We devise a tractable model of firm dynamics with on-the-job search. The model admits analytical solutions for equilibrium outcomes, including quit, layoff, hiring and vacancy filling rates, as well as the distributions of job values, a fundamental challenge posed by the environment. Optimal labor demand takes a novel form whereby hiring firms allow their marginal product to diffuse over an interval. The evolution of the marginal product over this interval endogenously exhibits gradual mean reversion, evoking a notion of imperfect labor market competition. This in turn contributes to dispersion in marginal products, giving rise to endogenous misallocation. Mirroring establishment microdata, quit and layoff rates fall, while hiring and vacancy-filling rates rise with firm growth in the model. We further show how it is possible to solve for the dynamic equilibrium path of model outcomes—including the distribution of job values—out of steady state.

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