| Summary: | What determines the comovements of aggregate employment and wages? This classic question in macroeconomics has received renewed attention since the Great Recession, when real wages did not fall despite a crash in employment. This paper proposes a microfoundation for the short-run dynamics of aggregate labor markets which relies on worker heterogeneity. I develop a model in which workers differ in their skills for various occupations, sectors employ occupations with different weights in production, and skills are imperfectly transferable. When shocks are concentrated in particular sectors, the extent to which workers can reallocate across the economy determines aggregate labor market dynamics. I apply the model to study the recession of 2008-09. I estimate the distribution of worker skills using two-period panel data prior to the recessions. Shocking the estimated model with sector-level TFP series replicates the increase in aggregate wages in 2008-09, and decline in 1990-91. The model implies that if either the composition of sector shocks or the distribution of skills in the economy had been the same in the 2008-09 recession as in the 1990-91 recession, real wages would have fallen, while employment would have declined less. This is because skills became less transferable between the 1980s and 2000s. In addition, the declining sectors during 2008-09 all employed a similar mix of skills, which induced many low-skill workers to leave the labor force and limited downward wage pressure on the rest of the economy. Finally, the model suggests a reduced form method to correct aggregate wages for selection in the human capital of workers, which accounts for cyclical job downgrading by focusing on the wage movements of occupation-stayers and recovers wage declines during the Great Recession.
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