Inefficient Unemployment Dynamics under Asymmetric Information

Abstract

I explore the efficiency properties of a competitive search model with match‐specific private information and limited commitment on the workers’ side. In a static setting the competitive search equilibrium is constrained efficient, whereas in a dynamic setting it is constrained inefficient whenever the initial unemployment rate is different from its steady‐state level. Inefficiency arises because the workers’ outside option becomes endogenous and affects the severity of the distortion due to the informational friction. This generates a novel externality: firms offering contracts at a given time do not internalize their effect on the outside option of workers hired in previous periods.