Shopping Externalities and Self Fulfilling Unemployment Fluctuations*

the evidence brought forward that …rm’s …nancial distress increases only temporarily during2007 and 2008 (see Atkeson, Eisfeldt and Weill 2012). And the structural transformationview does not explain the large movements in the stock market than have accompanied theincrease in unemployment.Farmer (2012a, b) was the …rst to propose an explanation of the Great Recession basedon non-fundamental shocks. In Farmer’s model, wages are pinned down by neither competitiveforces nor bargaining forces. Rather, wages are determined by sentiments. The GreatRecession can be explained as the consequence of an increase in real wages that leads to anincrease in the unemployment rate, to a decline in the labor-to-capital ratio and, ultimately,to a stock market crash. Despite the obvious similarities, there are important di¤erencesbetween Farmer’s paper and ours, both theoretically and empirically. From the theoreticalpoint of view, wages are indeterminate in Farmer, while in our model they are uniquelypinned down by the process of bargaining between individual …rms and individual workers.From the empirical point of view, Farmer’s model predicts that real labor productivity andreal wages should have increased during the Great Recession, while our model predicts thatreal labor productivity would not have changed and that real wages should have declined.While the evidence on wages is hard to interpret in the context of search models of the labormarket, the evidence on labor productivity seems more supportive of our model.2 Environment and Equilibrium ConditionsWe develop a model economy with search frictions in both the labor and the product markets.We model the product market as in Burdett and Judd (1983). In this market, searchfrictions generate an equilibrium distribution of prices for identical goods and unemployedworkers, having more time to search, end up paying lower prices. Moreover, the competitivenessof this market depends on the intensity of buyers’search which, in turn, depends onthe unemployment rate. We model the labor market as in Mortensen and Pissarides (1994).In this market, matching frictions generate equilibrium unemployment and income di¤erencesbetween employed and unemployed workers. Our model economy is simple enough toa¤ord an analytic characterization of the equilibrium set, and it is rich enough to a¤ord aquantitative evaluation of its implications.2.1 EnvironmentThe economy is populated by two types of agents— workers and …rms— who exchange threegoods— labor and two consumption goods. Labor is traded in a decentralized and frictional7