Pigou Cycles in Closed and Open Economies with Matching Frictions

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We show that a simple labor market matching model can generate Pigou cycles, that is, a positive comovement in consumption, investment, and employment in response to news about future macroeconomic developments. However, investment moves in the right direction for only a small set of parameter values. This paper shows that an open-economy version in which international capital flows dampen domestic interest rate responses can robustly generate Pigou cycles. In models with a spot market for labor, sticky interest rates reinforce the wealth effect and make it more difficult to generate Pigou cycles. In a matching model, however, both the demand for and the supply of labor are investment decisions, and sticky interest rates reinforce the increase in these investments following a positive news shock. The stronger employment response raises the expected return on capital, which ensures a robust increase in capital investment as well.