Unemployment Introduction Seyed Ali Madanizadeh Sharif U. of Tech. May 16, 2014 Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 1 / 32
Outline Participation rate The fraction of the active population (age 16-64) that either holds a job or is looking for one. This group is called the LABOR FORCE. Employment rate The fraction of people in the labor force that holds a job Hours per Worker For someone who holds a job, the average number of yearly hours. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 2 / 32
Outline TOTAL HOURS PER PERSON (THP): THP = Participation x Employment x HoursperWorker Fact The biggest component of the variation in hours is fluctuations in the level of employment.(shimer (2010), Lilien and Hall, (1986)) It is equivalent to understanding UNEMPLOYMENT. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 3 / 32
Outline Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 4 / 32
Outline 81 Mi I 4% 25% 3% 4% 140 Mi E 25% 2% 14 Mi U Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 5 / 32
Outline Unemployment rate = fraction of labor force who are unemployed Two focuses: Long term Unemployment Unemployment fluctuations u = U U + E To understand unemployment: Flows IN and OUT of unemployment. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 6 / 32
Outline In an accounting sense Unemployment can increase for at least three reasons: E U rises. People are losing jobs. U E lower. It is harder to find jobs. U I lower or I U higher. More people are looking for jobs. (not necessarily a bad thing) Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 7 / 32
Theories of unemployment In a competitive model: Supply = Demand No Unemployment in equilibrium We need a model that generates unemployment and it fluctuations Search theory by Dale Mortensen, Chris Pissarides and Peter Diamond A Theory of search and job finding Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 8 / 32
Model No inactivity: All the workers are employed or unemployed in each point in time. With probability λ unemployed workers receive an acceptable job offer. With probability δ employed workers lose their jobs. These represent layoffs and quits. Note: in competitive model λ = 1 Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 9 / 32
Outline In the data, λ = 0.34 per month (in average). This implies an average unemployment duration of 2.9 months. δ 0.02 per month (in average). This implies an average job tenure of 50 months. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 10 / 32
Search Theory E 35% 2% U Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 11 / 32
Search Theory Assume that the labor force is constant L t = L E t + U t = L Transition probability generates a dynamic equation for employment and unemployment: U t+1 = (1 λ) U t + δe t Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 12 / 32
Search Theory Combining the two: U t+1 = (1 λ) U t + δ (L U t ) Diving by L u t+1 = (1 λ δ) u t + δ = G (u t ) We got a linear DIFFERENCE EQUATION where (1 λ δ) < 1 Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 13 / 32
Search Theory It has a unique steady state: The steady state unemployment u = (1 λ δ) u + δ u = δ λ + δ Call this the NATURAL UNEMPLOYMENT RATE. With the previous data for US we get: u 0.054 Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 14 / 32
Search Theory Thus far, the model can explain the existence of long-run unemployment. It has no business cycles, though. In order to create fluctuations we endogenize λ. We keep δ exogenous. We concluded before that fluctuations in u are due to fluctuations in λ. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 15 / 32
Search Theory Now we introduce the variable V t, which denotes the number of vacancies created by firms each period. Also, let v t = V t L be the vacancy rate. We introduce the concept of the matching function. If U t workers and V t vacancies are looking for matches, M (U t, V t ) matches are created. For simplicity, let M (U t, V t ) = U α t V 1 α t Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 16 / 32
Search Theory Therefore since V t U t = v t u t λ = M (U ( ) t, V t ) 1 α Vt = U t U t λ = ( ) 1 α vt u t Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 17 / 32
Search Theory Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 18 / 32
Search Theory Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 19 / 32
Search Theory Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 20 / 32
Search Theory Recessions are a period when v t : A t reduces the profitability of jobs for firms. Thus, it reduces the incentive for firms to hire. i.e. Vacancies are procyclical. (this can be formalized in a model) Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 21 / 32
Search Theory The mechanism that employment goes down in recessions is: A t Profitability of firms goes down; and so does the incentives to hire more (open vacancies) ( ) 1 α λ = vt u t : It s harder to find a job u t Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 22 / 32
Search Theory Note that this implies a NEGATIVE relationship between vlt and u t This is called the Beveridge curve. Named after William Beveridge. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 23 / 32
Search Theory Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 24 / 32
Search Theory What happened in late 2009? One explanation: mismatch. Job vacancies are in different industries/regions than the job seeker. e.g. construction workers lost their jobs and cannot find jobs as nurses. Can be seen as a decrease in the effi ciency of matching M(U, V ). Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 25 / 32
Natural rate of unemployment This concept was introduced by Milton Friedman and Edmund Phelps in the 60s. The cost of gathering information about job vacancies and labor availability, the costs of mobility. It reflects the "normal" time it takes people to find an appropriate job, and for firms to find suitable workers. In that sense this level of unemployment is not a "bad" thing. It just reflects the nature of the job search technology. In normal times American workers find jobs very fast. Forcing people to take bad jobs may damage the economy. Let s look at the DETERMINANTS of the natural rate. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 26 / 32
Determinants of Unemployment Several factors other than the search process that affect this rate. Many of those are determined by government policy. Unemployment insurance: the government pays unemployed workers a fraction of their wage after they lose a job for a limited time. This fraction is called the replacement rate. This provides relief to workers upon a negative event. On the other hand it reduces the incentives for workers to look for jobs. Lots of empirical evidence support this last point. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 27 / 32
Determinants of Unemployment Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 28 / 32
Determinants of Unemployment Note: this per se does not make it a bad policy. The reason it was designed was to provide INSURANCE. In the US 50% of job losers have zero liquid wealth. This could force people to take bad jobs just to pay the bills. Chetty (2008) estimates that 60% of that spike comes from these liquidity constrained people. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 29 / 32
Determinants of Unemployment Several other government policies affect unemployment: Labor taxes. Firing taxes and severance payments. Unionization of wages (rigid wages). Minimum wages. Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 30 / 32
Determinants of Unemployment Minimum wage or rigid wages W S W * D D L * Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 31 / 32
Determinants of Unemployment Labor market policies are regarded as being the main reason for the large increase in Europe unemployment throughout the 80s and 90s. In the current recession many economists estimate that UI are part of the reason for the large increase in the unemployment rate in the US. UI benefits were extended from 26 weeks to 99 - weeks (unprecedented). Several economists estimated that this increase is responsible for 0.4 1.5% points of the increase in unemployment in this recession (u increased from 5% to 10%) Seyed Ali Madanizadeh (Sharif U. of Tech.) Unemployment Introduction May 16, 2014 32 / 32