Abstract

This paper studies the role of capital investment in a search and matching model. I develop an endogenous job separation matching model in which a firm's irreversible capital investment is endogenously determined. The incorporation of capital investment provides an additional channel for firms to respond to productivity shocks, significantly magnifying labor market fluctuations. The numerical results demonstrate that the incorporation of irreversible capital investment improves the ability of the standard search and matching model to generate cyclical fluctuations of unemployment and vacancies in response to productivity shocks. Moreover, my model can generate the pro-cyclicality of vacancies, which the standard endogenous separation models often fail to generate.