The Cyclicality of Labor Force Participation Flows: The Role of Labor Supply Elasticities and Wage Rigidity

56 Pages Posted: 9 Jun 2020

See all articles by Isabel Cairo

Isabel Cairo

Board of Governors of the Federal Reserve System

Shigeru Fujita

Federal Reserve Bank of Philadelphia

Camilo Morales-Jimenez

Board of Governors of the Federal Reserve System

Date Written: June, 2020

Abstract

Using a representative-household search and matching model with endogenous labor force participation, we study the cyclicality of labor market transition rates between employment, unemployment, and nonparticipation. When interpreted through the lens of the model, the behavior of transition rates implies that the participation margin is strongly countercyclical: the household’s incentive to send more workers to the labor force falls in expansions. We identify two key channels through which the model delivers this result: (i) the procyclical values of non-market activities and (ii) wage rigidity. The smaller the value of the extensive-margin labor supply elasticity is, the stronger the first channel is. Wage rigidity helps because it mitigates increases in the return to market work during expansions. Our estimated model replicates remarkably well the behavior of transition rates between the three labor market states and thus the stocks, once these two features are in place.

JEL Classification: E24, J64

Suggested Citation

Cairo, Isabel and Fujita, Shigeru and Morales-Jimenez, Camilo, The Cyclicality of Labor Force Participation Flows: The Role of Labor Supply Elasticities and Wage Rigidity (June, 2020). FRB of Philadelphia Working Paper No. 20-23, Available at SSRN: https://ssrn.com/abstract=3622471 or http://dx.doi.org/10.21799/frbp.wp.2020.23

Isabel Cairo (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Shigeru Fujita

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Camilo Morales-Jimenez

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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