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The (un)importance of unemployment fluctuations for welfare

  • Philip Jung
  • Keith Kuester

This paper develops a real business cycle model with labor market search and matching frictions, which endogenously links both the cyclical fluctuations and the mean level of unemployment to the aggregate business cycle risk. The key result of the paper is that business cycles are costly for all consumers, regardless of their wealth, yet that unemployment fluctuations themselves are not the source of these costs. Rather fluctuations over the cycle induce higher average unemployment rates as employment is non-linear in job-finding rates and past unemployment. The authors first show this result analytically in special cases. They then calibrate a general equilibrium model with risk-averse asset-holding and liquidity-constrained workers to US data. Also under these more general circumstances, business cycles mean higher unemployment for all workers. The ensuing costs of cycles rise further for liquidity-constrained agents when replacement rates are lower or when workers' skills depend on the length of (un)employment spells.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 08-31.

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Date of creation: 2008
Date of revision: 29 Apr 2009
Handle: RePEc:fip:fedpwp:08-31
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