Macroeconomic Shocks and Dynamics of Labor Markets in Korea

Abstract

A New Keynesian model with labor friction, in which involuntary unemployment can be endogenized, is estimated with the Korean macroeconomic data using a Bayesian estimation approach. The model is extended by specifying a small open economy with tradable and nontradable goods sectors to characterize the Korean labor market empirically. Results of empirical analyses based on the estimated model can be summarized as follows. First, the sectoral reallocation of labor plays an important role in the adjustment of the Korean labor market, which responds to macroeconomic shocks, particularly foreign shocks. Second, the historical decomposition analysis demonstrates that the cyclical fluctuations of unemployment in Korea are explained by key domestic shocks, such as domestic productivity shocks and preference shocks. A relatively small contribution of foreign shocks to aggregate labor market variables is partly caused by the sectoral shift of employment rather than extensive changes in aggregate employment and labor force