Out of work, out of the labour force? Attachment, search effort and participation flows

Cyclical movements in labour market slack depend not only on job losses and hiring, but also on which workers find themselves unemployed at different points in time and how likely they are to remain in the labour force. Using data from the UK Labour Force Survey (LFS), we show that the procyclicality in the rate at which unemployed workers leave the labour force is strongly correlated with compositional changes in the unemployment pool. Workers who enter unemployment following job loss are substantially less likely to exit the labour force than workers who enter unemployment from inactivity. We document that whether an unemployed worker was previously employed or inactive is the strongest predictor of their attachment to the labour market, and show that this is not explained by variation in search effort. Motivated by these findings, we extend a Diamond-Mortensen-Pissarides search-and-matching model to allow for heterogeneous labour market attachment among the unemployed. Fluctuations in job separations change the composition of the unemployment pool and amplify unemployment fluctuations relative to the standard model. Quantitatively, this mechanism increases unemployment volatility by around 50%, and helps the model account for the sharp rise in unemployment at the onset of the Great Recession.