A Congestion Theory of Unemployment Fluctuations

We propose a theory of unemployment fluctuations in which new-hires and incumbent-workers are imperfect substitutes. Hence, attempts to hire away the unemployed during recessions diminish the marginal product of new hires, discouraging job creation. This single feature achieves a ten-fold increase in the volatility of hiring in an otherwise standard search model, produces a realistic Beveridge curve despite countercyclical separations, and explains 30–40% of US unemployment fluctuations. Additionally, it explains the excess procyclicality of new hires’ wages, the cyclical labor wedge, countercyclical earnings losses from job displacement, and the limited steady-state effects of unemployment insurance.