Abstract We investigate the connection between commodity price shocks and unemployment in advanced resource-rich small open economies from an empirical and theoretical perspective. Shocks to commodity prices are shown to influence labour market conditions primarily through the real exchange rate. The empirical impact of commodity price shocks is obtained from estimating a panel vector autoregression; a positive price shock is found to expand the components of GDP, to cause the real exchange rate to appreciate, and to improve labour market conditions. For every one percent increase in commodity prices, our estimates suggest a one basis point decline in the unemployment rate and at its peak a 0.3% increase in unfilled vacancies. We then match the impulse responses to a commodity price shock from a small open economy model with net commodity exports and search and matching frictions in the labour market to these empirical responses. As in the data, an increase in commodity prices raises consumption demand in the small open economy and induces a real appreciation. Facing higher relative prices for their goods, non-commodity producing firms post additional job vacancies, causing the number of matches between firms and workers to rise. As a result, unemployment falls, even if employment in the commodity-producing sector is negligible. JEL classifications: E44, E61, F42.

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We study the effect of mean-preserving idiosyncratic industry shocks on business cycle outcomes. We develop an empirical methodology using a local area’s exposure to industry reallocation based on the area’s initial industry composition and employment trends in the rest of the country over a full employment cycle. Using confidential employment data by local area and industry over the period 1980-2014, we find sharp evidence of reallocation contributing to worse employment outcomes during national recessions but not during national expansions. We repeat our empirical exercise in a multi-area, multi-sector search and matching model of the labor market. The model reproduces the empirical results subject to inclusion of two key, empirically plausible frictions: imperfect mobility across industries, and downward nominal wage rigidity. Combining the empirical and model re-sults, we conclude that reallocation can generate substantial amplification and persistence of business cycles at both the local and the aggregate level.

The cyclicality of a job’s surplus is of central importance for the Mortensen-Pissarides theory of labor markets, but is not directly observable. A typical identifying assumption is that hours are chosen to maximize the surplus, which eliminates cyclical improvements in the allocation of hours within a match as a determinate of the surplus. However, when aggregate fluctuations are driven by shocks to labor productivity, this implication is inconsistent with the empirical behavior of hours per worker. I relax this assumption and quantify the impact on employment volatility. If the model is made consistent with the observed negative comovement of hours per worker and productivity, then the unemployment rate becomes substantially more volatile because the job surplus fluctuates more procyclically as hours are allocated more efficiently during expansions and less efficiently during recessions. 1 1