A Congestion Theory of Unemployment Fluctuations

Abstract

In recessions, unemployment increases despite the—perhaps counterintuitive—fact that the
number of unemployed workers finding jobs expands. On net, unemployment rises only because
even more workers lose their jobs. We propose a theory of unemployment fluctuations resting on
this countercyclicality of gross flows from unemployment into employment. In recessions, the
abundance of new hires “congests” the jobs the unemployed fill, diminishes their marginal product
and discourages further job creation. Countercyclical congestion alone explains about 30–40
percent of U.S. unemployment fluctuations. Besides generating realistic labor market volatility, it
also provides a unified explanation for the cyclical labor wedge, the excess earnings losses from
job displacement and from graduating during recessions, and the insensitivity of unemployment
to labor market policies, such as unemployment insurance.

JEL Classification: E240, J630, J640