A Forest Fire Theory of Recessions and Unemployment
Matthew O. Jackson
Stanford University - Department of Economics; Santa Fe Institute; Canadian Institute for Advanced Research (CIFAR)
Stanford University - Department of Economics
August 1, 2013
We develop a model of matching from firms' perspectives and draw resulting conclusions for the macro-dynamics of an economy. The key insight is that firms may wish to hire workers that are bad matches (having low productivity) in high-demand states, even if the worker must be hired to a long-run contract. This results an increasing fraction of bad worker-firm matches as an economy booms, making it increasingly likely that a recession will occur the longer it has been since the last recession, and increasing the depth of the recession when it occurs. While employment is lowest immediately following a recession, an economy has its highest fraction of good to bad matches as it emerges from a recession. These dynamics result in fully-rational, endogenous business cycles featuring non-stationary distributions of unemployment for a given stationary exogenous shock: in particular, the longer it has been since the last recession the more fragile the economy becomes and the more dramatic its response to exogenous shocks. Examining both US industry-level data from 1948-2011, and US economic areas data from 1970-2010, we find that the longer the time elapsed since the last recession, the larger the drop in employment during the recession.
Number of Pages in PDF File: 33
Keywords: recessions, employment, unemployment, matching, search, business cycles, macro-dynamics
JEL Classification: E24, E32, D92, D21, D22working papers series
Date posted: July 8, 2013 ; Last revised: December 1, 2013
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