Productivity, Aggregate Demand And Unemployment Fluctuations

What drives unemployment fluctuations at business cycle frequencies? Since the seminal work of Mortensen-Pissarides (1994), a vast literature, including the influential work from Shimer (2005a), has focused on labor productivity to explain movements in unemployment.1 In a Mortensen-Pissarides (MP) search and matching model, an increase in productivity raises the surplus of a match between a firm and a worker, leads firms to post more job vacancies and pulls down the unemployment rate. Shifts in labor demand are caused by changes in productivity, and productivity is seen as the central driving force of unemployment fluctuations.