A New Keynesian model with labor friction, in which involuntary unemployment can be
endogenized, is estimated with the Korean macroeconomic data using a Bayesian estimation
approach. The model is extended by specifying a small open economy with tradable and
nontradable goods sectors to characterize the Korean labor market empirically. Results of
empirical analyses based on the estimated model can be summarized as follows. First, the
sectoral reallocation of labor plays an important role in the adjustment of the Korean labor
market, which responds to macroeconomic shocks, particularly foreign shocks. Second, the
historical decomposition analysis demonstrates that the cyclical fluctuations of
unemployment in Korea are explained by key domestic shocks, such as domestic productivity
shocks and preference shocks. A relatively small contribution of foreign shocks to aggregate
labor market variables is partly caused by the sectoral shift of employment rather than
extensive changes in aggregate employment and labor force.