Discouragement in an Equilibrium Search Model With Type Uncertainty∗

This paper relaxes a single assumption in the standard matching framework, by allowing unemployed workers to be uncertain about their relative ability to find a job. This alternative assumption, which is supported by experimental evidence, implies that unsuccessful search induces individuals to revise their beliefs downwards. Once self-confidence is sufficiently low, workers become discouraged and give up on search. Without the need for shocks, this non-stationarity gives rise to structural flows from unemployment to non-participation in equilibrium. The hazard of moving from unemployment to employment declines with unemployment duration, due to erosion of self-confidence in search. Falling self-confidence also leads to equilibrium wages declining with unemployment duration, even with homogeneous productivity of workers. Individual search histories matter for confidence, so discouraged workers may not resume search even after a positive aggregate productivity shock. We discuss how the model provides a unifying explanation for a variety of important facts from field evidence.