The Unemployment Volatility Puzzle: The Role of Matching Costs Revisted

Pissarides has argued that the standard search model with sunk fixed matching costs increases unemployment volatility without introducing an unrealistic response of wages of new matches to productivity shocks. We revise the role of matching costs and show that when these costs are not sunk and, therefore, can be partially passed on to new hired workers in the form of lower wages, the amplification mechanism of fixed matching costs is considerably reduced. Finally, we observe that an empirical reasonable share of sunk costs is not able to match the volatility of unemployment without introducing unrealistic sensitivity to unemployment benefits. (JEL E32, J32, J64)