Decomposing Shifts in the Beveridge Curve: Implications for Labor Market Dynamics and Inflation

This paper explores the relationship between standard labor market tightness (vacancies divided by unemployment) and generalized labor market tightness (vacancies divided by a measure of effective searchers that accounts for potential hires from all sources including those out of the labor force or currently employed). We show that much of what the standard model attributes to variation in matching efficiency reflects changes in the ratio of effective searchers to unemployment rather than changes in “true” matching efficiency. Generalized tightness outperforms standard tightness in Phillips curve equations, both in models with tightness entering linearly and in better-fitting models with tightness entering nonlinearly. In models that distinguish between movements in generalized tightness due to movements along the generalized Beveridge curve versus Beveridge curve shifts (reflecting changes in generalized matching efficiency and other factors), changes in tightness due to Beveridge curve shifts explain more of the variation in inflation.