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. 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 - diminishing their marginal product and discouraging further job creation. Countercyclical congestion explains 30-40% of US unemployment fluctuations. Additionally, it explains the excess procyclicality of new hires' wages, the cyclical labor wedge, the large earnings losses from job displacement and from graduating during recessions, and the insensitivity of unemployment to policies such as unemployment insurance.

JEL Classification: E24, J63, J64