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Labour Policy Instruments and the Cyclical Behaviour of Vacancies and Unemployment

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Abstract

The standard Mortensen–Pissarides (MP) model cannot match the observed elasticity of vacancies and unemployment in the data. This paper shows that by introducing labour policy instruments, the original MP model can replicate the observed fluctuations in unemployment and job vacancies in response to shocks. These instruments reduce the benefit of forming a match, thereby increasing the impact that shocks have on firms' incentives to post vacancies, and workers' to accept job offers. Additionally, the analysis shows that the design of labour policy instruments, e.g. whether taxation is progressive or regressive, has non-trivial consequences on the model's performance.

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