Persistence of Employment Fluctuations: A Model of Recurring Job Loss

Abstract

Standard models of employment fluctuations cannot reconcile the unemployment rate's remarkable persistence with the high job-finding rates found in worker flows data. A matching model emphasizing high hazard rates among newly formed firm-worker matches can resolve this shortcoming. In the model, matches are experience goods; consequently, newly employed workers face higher hazard rates. Following a job loss, workers may experience several short-lived jobs before finding stable employment. At an aggregate level, an initial burst of job loss precipitates a steady flow of recurring job loss. A simulation shows that this recurring job loss can account for the fact that the unemployment rate remains elevated for as much as 4 or 5 years following an initial jump. Intuitively, the labour market frictions associated with the difficult and time-consuming process of matching unemployed workers with appropriate jobs represent an appealing way to enhance conventional dynamic general equilibrium models of economic fluctuations that generally exhibit very little internal propagation of business cycle shocks.1 Nevertheless, although conventional matching models, such as the canonical Mortensen and Pissarides (1994) model, successfully explain many other important features of the labour market, they fail to explain the high degree of persistence observed in the U.S. unemployment rate. The primary reason for this failure is that data on labour market flows show that unemployed workers actually find jobs quite quickly. Therefore, following a shock that triggers a burst of job loss, the high job-finding rate implies that the unemployment rate in these models returns quite rapidly back toward its average level. This represents a significant obstacle to the notion that frictions in the labour market account for much of the propagation of business cycle shocks. This paper asserts that existing matching models fail to capture an important feature of the labour market that can reconcile the dramatic persistence of the unemployment rate with the evidence of high job-finding rates. Specifically, although unemployed workers find jobs quickly, the newly found jobs often last only a short time. After an initial job loss, a worker may experience several short-lived jobs before settling into more stable employment. This recurring job loss slows the pace at which the unemployment rate returns to its normal level following an adverse shock.