Benjamin Schoefer, Professor, UC Berkeley
We propose a theory of labor market fluctuations based on "countercyclical congestion." Our starting point is that empirical unemployment-to-employment (UE) flows are countercyclical, due to countercyclical separations. That is, recessions are times when more unemployed workers find and start new jobs. Standard models either feature procyclical UE flows or permit firms to absorb these additional hires immediately and linearly. Yet, we show that empirical labor demand only sluggishly absorbs newly unemployed workers, a property we call congestion. We explore the resulting countercyclical congestion in a DMP model. Our specific congestion channel works through diminishing returns in the jobs these UE hires fill, which lowers their marginal product in recessions, amplifying the fluctuations of the productivity time series that is allocative for hiring. Our calibrated model simultaneously explains (i) the volatility of labor market variables, (ii) the strongly downward-sloping Beveridge curve, (iii) the cyclical behavior of the labor wedge, (iv) the countercyclical earnings losses upon job displacement, and (v) the relative insensitivity of labor market variables to labor market policies such as unemployment insurance.