Working Paper

Labor market dynamics with endogenous labor force participation and on-the-job search

Abstract: Empirical evidence shows that worker flows in the U.S. labor market are very large. Previous studies have mainly focused on documenting and modeling worker flows between employment and unemployment only. However, these studies ignore other important labor flows including movements in and out of the labor force, and worker flows from one job directly to another job. Improving our understanding of this broader set of labor market flows is critical for assessing the merits of labor market policies such as unemployment insurance and minimum wage. ; This paper focuses on the broader set of worker flows. In terms of magnitude, flows into and out of the labor force are as large as flows between employment and unemployment. And worker flows from one job directly to another job, termed job-to-job flows, account for the vast majority of worker separations from employment. More specifically, job-to-job flows constitute almost 40 percent of all separations from employment, and they are twice as large as flows from employment to unemployment. ; The main contribution of this paper is to develop a framework in which labor market flows between employment, unemployment and out of the labor force can be studied. Earlier attempts to incorporate the participation margin in the standard real business cycle framework have been discouraging in the sense that the model generated counterfactual results. This paper presents an alternative general equilibrium real business cycle model that features search and matching frictions, and endogenous labor force participation. The model additionally features on-the-job search to capture job-to-job flows, which are crucial for the U.S. labor market dynamics. The model successfully generates countercyclical unemployment and the negative correlation between unemployment and vacancies, also known as the Beveridge Curve, observed in the data. The business cycle statistics reproduced by the model are in line with their empirical counterparts.

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2012

Number: RWP 12-07