Unemployment Risk and Reallocation Over the Business Cycle

During economic downturns, labor markets are characterized not only by a higher unemployment rate and by lower transitions from unemployment to employment, but also by a reduction in the transitions from job to job. In this paper I propose a new mechanism to explain the reduction in job-to-job flows. I argue that when workers start a new job, the risk of separation is initially higher. Therefore, in a recession, workers are more reluctant to leave their existing jobs because they know that if they end up separating early from their new jobs, they would face longer unemployment spells. Using data from the Survey of Income and Program Participation (SIPP), I show that hazard rates of separation are initially high after a job-to-job transition. I then extend the job ladder model of Burdett and Mortensen (1998) to introduce the risk of early match dissolution and capture the mechanism described above. I estimate the model using U.S. data and find that workers’ reluctance to move generates a drop in the transition rate of 10 percentage points in a recession of the size of the Great Recession. Moreover, this mechanism generates a decrease in productivity of about 1 percent. ∗I am extremely grateful to my advisors, Guido Lorenzoni, Lawrence Christiano, and Martin Eichenbaum for their continuous guidance and support. I am also very thankful to David Berger, Matthias Doepke, Ruben Gaetani, Giuseppe Moscarini, Alessandro Pavan, Juan Prada, Giorgio Primiceri, and Yuta Takahashi for helpful comments and suggestions. I appreciate comments from all participants at the Northwestern Macroeconomics Lunch seminar. All errors are my own. Northwestern University, Department of Economics. Email: [email protected].