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The (un)importance of unemployment fluctuations for welfare

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Author Info
Philip Jung
Keith Kuester

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Abstract

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. The authors first show this result analytically in special cases. They 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 costs 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.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 08-31.

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Date of creation: 2008
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Handle: RePEc:fip:fedpwp:08-31

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Related research
Keywords: Unemployment ; Welfare ; Business cycles;

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  2. Jonathan Gruber, 2001. "The Wealth of the unemployed," Industrial and Labor Relations Review, ILR Review, ILR School, Cornell University, vol. 55(1), pages 79-94, October.
  3. Marcus Hagedorn & Iourii Manovskii, 2008. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," American Economic Review, American Economic Association, vol. 98(4), pages 1692-1706, September. [Downloadable!]
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  4. David Domeij & Martin Floden, 2006. "The Labor-Supply Elasticity and Borrowing Constraints: Why Estimates are Biased," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(2), pages 242-262, April. [Downloadable!] (restricted)
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  5. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Working Papers 11523, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Andrew Atkeson & Christopher Phelan, 1994. "Reconsidering the Costs of Business Cycles with Incomplete Markets," NBER Chapters, in: NBER Macroeconomics Annual 1994, Volume 9, pages 187-218 National Bureau of Economic Research, Inc. [Downloadable!]
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  7. Wouter J. den Haan & Garey Ramey & Joel Watson, 2000. "Job Destruction and Propagation of Shocks," American Economic Review, American Economic Association, vol. 90(3), pages 482-498, June. [Downloadable!] (restricted)
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  8. Per Krusell & Anthony A. Smith, Jr., 1999. "On the Welfare Effects of Eliminating Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 245-272, January. [Downloadable!] (restricted)
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  9. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March. [Downloadable!]
  10. Dale Mortensen & Eva Nagypal, 2007. "More on Unemployment and Vacancy Fluctuations," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(3), pages 327-347, July. [Downloadable!] (restricted)
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  11. Mukoyama, Toshihiko & Sahin, Aysegul, 2006. "Costs of business cycles for unskilled workers," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 2179-2193, November. [Downloadable!] (restricted)
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  12. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Blackwell Publishing, vol. 61(3), pages 397-415, July. [Downloadable!] (restricted)
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  13. Gadi Barlevy, 2005. "The cost of business cycles and the benefits of stabilization," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 32-49. [Downloadable!]
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  15. Tom Krebs, 2003. "Growth and Welfare Effects of Business Cycles in Economies with Idiosyncratic Human Capital Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 846-868, October. [Downloadable!] (restricted)
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  17. Engen, Eric M. & Gruber, Jonathan, 2001. "Unemployment insurance and precautionary saving," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 545-579, June. [Downloadable!] (restricted)
  18. Tom Krebs, 2007. "Job Displacement Risk and the Cost of Business Cycles," American Economic Review, American Economic Association, vol. 97(3), pages 664-686, June. [Downloadable!]
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  19. Jacobson, Louis S & LaLonde, Robert J & Sullivan, Daniel G, 1993. "Earnings Losses of Displaced Workers," American Economic Review, American Economic Association, vol. 83(4), pages 685-709, September. [Downloadable!] (restricted)
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  20. Hairault, Jean-Olivier & Langot, François & Osotimehin, Sophie, 2008. "Unemployment Dynamics and the Cost of Business Cycles," IZA Discussion Papers 3840, Institute for the Study of Labor (IZA). [Downloadable!]
  21. Storesletten, Kjetil & Telmer, Chris I. & Yaron, Amir, 2001. "The welfare cost of business cycles revisited: Finite lives and cyclical variation in idiosyncratic risk," European Economic Review, Elsevier, vol. 45(7), pages 1311-1339. [Downloadable!] (restricted)
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  22. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January. [Downloadable!] (restricted)
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  23. Shigeru Fujita & Garey Ramey, 2007. "The cyclicality of separation and job finding rates," Working Papers 07-19, Federal Reserve Bank of Philadelphia. [Downloadable!]
  24. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March. [Downloadable!]
  25. Keane, Michael P & Wolpin, Kenneth I, 1997. "The Career Decisions of Young Men," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 473-522, June.
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  26. Beaudry, Paul & Pages, Carmen, 2001. "The cost of business cycles and the stabilization value of unemployment insurance," European Economic Review, Elsevier, vol. 45(8), pages 1545-1572, August. [Downloadable!] (restricted)
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  27. James S. Costain & Michael Reiter, 2004. "Stabilization versus insurance: welfare effects of procyclical taxation under incomplete markets," Economics Working Papers 890, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2005. [Downloadable!]
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  28. Gadi Barlevy, 2004. "The Cost of Business Cycles Under Endogenous Growth," American Economic Review, American Economic Association, vol. 94(4), pages 964-990, September. [Downloadable!]
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  29. N. Gregory Mankiw, 2000. "The Savers-Spenders Theory of Fiscal Policy," NBER Working Papers 7571, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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