Labor supply shocks and unemployment persistence

Our small empirical stock-flow model for the Dutch economy, which endogenizes the adjustment dynamics to (un)employment search equilibria, identifies two mechanisms that caused persistente in labor market adjustments: (i) job competition from non-participants, and (ii) asymmetrie adjustments to cyclical shocks. At the core of the model is an estimated matching function. Using Dutch flow data for the period 1970-1997 we tìnd that the search effectiveness of individuals on welfare benefits and non-participation is 0.33 respectively 0.05 of the search effectiveness of individuals receiving unemployment insurance. In accordance with actual developments in the reference period, our model simulations show that, when the flow from non-participants into the labor market rises permanently, the unemployment rate rises quickly and stabilizes at a higher leve1 whereas employment continues to rise. Yet, a sensitivity analysis with altemative assumptions on the type of supply shocks and the reaction of labor demand to these shocks indicates that the adjustment dynamics, and hence the degree of persistente, depend much on the search behavior of non-participants.