Unemployment Crises

Abstract

A search and matching model, when calibrated to the mean and volatility of unemployment in the postwar sample, can potentially explain the unemployment crisis in the Great Depression. The limited responses of wages from credible bargaining to labor market conditions, along with the congestion externality from matching frictions, cause the unemployment rate to rise sharply in recessions but decline gradually in booms. The frequency, severity, and persistence of unemployment crises in the model are quantitatively consistent with U.S. historical time series. The welfare gain from eliminating business cycle fluctuations is large.

Keywords: Search and matching frictions, unemployment crises, the unemployment volatility puzzle, projection, nonlinear impulse response functions, the Great Depression

JEL Classification: E24, E32, J63, J64