Uncertainty, Productivity and Unemployment in the Great Depression

The current 2007-2010 recession has witnessed two phenomena that standard search models of the labor market have diculty reconciling: a large and persistent increase in unemployment and a sharp rise, above pre-recession levels, in labor productivity following a small initial drop. In addition, these observations were accompanied by a signicant increase in the dispersion of rm growth rates. In this paper, I develop a tractable dynamic search model of heterogeneous rms with decreasing returns, in which I introduce uncertainty shocks. An increase in the idiosyncratic uncertainty faced by rms leads to higher unemployment, larger measured productivity, and more dispersion in rm growth rates. A combination of aggregate productivity and uncertainty shocks is able to explain many of the patterns observed in the ongoing recession, including the joint dynamics of unemployment and productivity. In addition to these ndings, the model performs well at explaining business cycle statistics in ordinary times and is able to reproduce a range of observations at the establishment and cross-sectional levels, such as the employment behavior of establishments.