The Scarring Effect of Asymmetric Business Cycles

Abstract

Business cycle fluctuations in the U.S. employment-to-population ratio are asymmetric: deviations below trend (troughs) are larger than deviations above trend (peaks). This asymmetry has a scarring effect, which reduces the average level of the employment-to-population ratio around which the economy fluctuates. To quantify such a scar, we formulate an equilibrium business cycle model featuring frictional unemployment and a labor force participation choice that produces the observed labor market asymmetry in the face of symmetric business cycle shocks. We quantify that the employment-to-population ratio would be 0.3 percentage points higher in the absence of cyclical fluctuations. Further, by dampening business cycles, counter-cyclical stabilization policy reduces the job loss by 70%.