The (Un)Importance of Unemployment Fluctuations for Welfare
34 Pages Posted: 6 Feb 2009
Date Written: December 12, 2008
This paper develops a real business cycle model with labor market search and matching frictions, which endogenously links both the cyclical fluctuations and the mean level of unemployment to the aggregate business cycle risk. The key result of the paper is that business cycles are costly for all consumers, regardless of their wealth, yet that unemployment fluctuations themselves are not the source of these costs. Rather fluctuations over the cycle induce higher average unemployment rates as employment is non-linear in job-finding rates and past unemployment. We first show this result analytically in special cases. We then calibrate a general equilibrium model with risk-averse asset-holding and liquidity-constrained workers to US data. Also under these more general circumstances, business cycles mean higher unemployment for all workers. The ensuing cost of cycles rise further for liquidity-constrained agents when replacement rates are lower or when workers' skills depend on the length of (un)employment spells.
Keywords: Cost of business cycles, unemployment, search and matching
JEL Classification: E32, E24, J64
Suggested Citation: Suggested Citation