Firing costs in a business cycle model with endogenous separations

Abstract

Purpose – The purpose of this paper is to introduce productivity-dependent firing costs into an otherwise standard endogenous separations matching model. The authors suggest an alternative to the standard fix cost approach and account for empirical evidence emphasizing that firing costs vary across workers. The authors show that the model with firing costs outperformes the model without firing costs and replicates the empirical facts fairly well. Furthermore, the authors present cross-country evidence that countries with stricter employment protection have a weaker Beveridge curve relation and surprisingly more volatile job flow rates. Design/methodology/approach – The authors begin the analysis at the intersection of labor and product markets. For this purpose, the authors derive a real business cycle model with search and matching frictions and endogenous separations. The authors enrich this set-up by introducing productivity-dependent firing costs. Findings – The authors show that the model with firing costs outperformes the model without firing costs and replicates the empirical facts fairly well. Furthermore, the authors present cross-country evidence that countries with stricter employment protection have a weaker Beveridge curve relation and surprisingly more volatile job flow rates. Originality/value – This paper introduces productivity-dependent firing costs into an otherwise standard endogenous separations matching model. The authors suggest an alternative to the standard fix cost approach and account for empirical evidence emphasizing that firing costs vary across workers. The authors show that the model with firing costs outperformes the model without firing costs and replicates the empirical facts fairly well. Furthermore, the authors present cross-country evidence that countries with stricter employment protection have a weaker Beveridge curve relation and surprisingly more volatile job flow rates.