Why Does Employment in All Major Sectors Move Together over the Business Cycle?

In recessions, employment falls in all major sectors. Positive correlation of employment across sectors is a puzzle, because a standard two-sector business-cycle model driven by aggregate productivity shocks predicts negative correlation of total hours of work in the consumption-goods sector and the investment-goods sector. I start from the observation that most of the variability of total hours worked takes the form of variations in the number of workers. Hours per employed worker is only a secondary source of variation. The exten- sive margin is therefore critical in understanding the positive correlation of sectoral labor market variables, yet neglected by existing studies. This paper advances the literature on cross-sectoral correlation of employment by making unemployment an explicit feature of the model. I construct a two sector model with search and matching friction, capital ad- justment costs, and partial wage stickiness. The model explains the positive cross-sectoral correlation through movements of workers in both sectors into and out of unemployment.