Authors
Abstract
To challenge and improve business cycle models of labor markets, we use data on separations into non-employment by destination and reason. Standard models where layoffs are random and quits are selective send too many laid-off workers to unemployment– empirically, a third leave the labor force– and they get the cyclical direction of labor force attachment backward. Adding selective layoffs and random quits resolves these issues and clarifies two channels that affect how labor markets evolve during recessions: (i) labor supply increases as marginal workers hoard their jobs and the displaced keep searching, and (ii) selection in layoffs shifts from marginal toward attached workers. Consequently, output per worker falls through composition rather than TFP, and the welfare cost of recessions is less than half that of the standard model. Through these channels, the volatility of the jobless who want to work is further disconnected from measured unemployment, a prediction we confirm in the data.