Rational Inattention in Hiring Decisions

The Great Recession observed a severe decline in labor market matching efficiency. Using the standard random search framework, we build a model of rational inattention in firm's hiring decisions. Firms ex-ante do not know the productivity of the worker they encounter and must expend resources to reduce their uncertainty over the worker's type. The cost of getting information, however, is rising in the dispersion of the pool of unemployed job-seekers. Selective hiring standards during a downturn further exacerbate this cost of acquiring information as the higher standards for retaining existing workers raises the disparity in the pool of job-seekers. These higher costs translate into lower acceptance probabilities and hiring rates by firms as firms now face a higher likelihood of making a mistake in terms of hiring low quality workers during the recession. Relative to the full information case, the model where firms are rationally inattentive can lead to amplifications in the unemployment rate and muted movements in the vacancy yield. These model-generated muted movements in vacancy yields and large declines in matching efficiency during a downturn are reminiscent of the behavior in hiring rates since the Great Recession.

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