Participation, Wage and Unemployment Fluctuations

Abstract

This paper studies the effects of endogenous participation on unemployment ‡fluctuations. It shows that the wage channel is the key to understanding them. Endogenous participation makes the expected outside options of workers countercyclical. Under Nash bargaining, this induces a countercyclical component in the wage equation. As a result, the elasticity of wage with respect to productivity becomes smaller and hence the model can generate larger unemployment ‡fluctuations. By calibrating the model to match some key observations of the U.S. labor market and goods market, I show that it can explain 45% of the unemployment volatility and 62% of job openings volatility.