## Introduction#

This course covers research topics related to unemployment. It discusses models used to describe unemployment, and policies used to tackle unemployment. It tries to answer several questions:

• Why does unemployment exist?
• Why does unemployment vary over the business cycle?
• What is the socially optimal level of unemployment?
• How should labor market policies respond to fluctuations in unemployment?

#### Introductory videos#

• Darity, Goldsmith (1996) – This survey reviews the social-psychological consequences of unemployment. It finds that exposure to unemployment severely damages psychological health.
• Di Tella, MacCulloch, Oswald (2003) – This paper finds in well-being surveys that unemployment make people unhappy. Being unemployed makes you unhappy, and having unemployment in your country makes you unhappy. In fact, they find after controlling for income and other personal characteristics that becoming unemployed is as painful as divorcing.

## Labor market facts and matching function#

This section reviews basic facts about the labor market and unemployment in the United States. We then introduce the matching function—the main tool that we will use to model the labor market and unemployment. The matching function summarizes the complex process through which workers searching for jobs and firms searching for employees meet each other.

#### Lecture videos#

• Elsby, Michaels, Ratner (2015) – This survey reviews the empirical properties of the Beveridge curve and possible microfoundations for it.
• Shimer (2012) – This paper shows that in the United States, unemployment fluctuations are caused by fluctuations in the job-finding rate and not fluctuations in the job-separation rate.
• Petrongolo, Pissarides (2001) – This survey reviews the microfoundations of the matching function, its empirical properties, and its applications.

## Matching model of the labor market#

This section introduces the matching model of the labor market. This is the model that we will use to study unemployment and labor market policies in this course. The model was developed by Peter Diamond, Dale Mortensen, and Christopher Pissarides in the 1980s—for this they received a Nobel Prize in 2010. In the matching model, unlike in the neoclassical model, all trades are mediated by a matching function. Nevertheless, we can construct labor supply and labor demand curves, and use them to solve the matching model.

#### Lecture videos#

• Kuhn (1992) – This book studies the Copernican Revolution in astronomy and in the process isolates the three properties of a good model: economy, accuracy, and fruitfulness.
• Pissarides (2001, chapter 1) – This chapter introduces the standard version of the labor-market matching model.
• Rogerson, Shimer, Wright (2005) – This survey reviews a range of matching models and search models.

## Wage functions#

This section discuss the labor market institutions that determine wages—such as unions, the minimum wage, and corporate policies. It then discusses various wage functions that can be used in the matching model to describe wages in worker-firm relationships—such as fixed wages, rigid wages, and bargained wages.

#### Lecture videos#

• Bewley (1999) – This book reports results from a survey of 300 business managers and labor leaders as well as professional recruiters in the United States. It explains how wages are set, why wages are rigid, and in particular why wages do not fall more in recessions.
• Akerlof (1984) – This survey reviews various theories of efficiency wages. These theories try to explain how firms set wages in practice. They consider the effect of wages on productivity, attachment to the firm, retention, hiring, and so on.
• Haefke, Sonntag, Van Rens (2013) – This paper estimates that real wages for new hires are somewhat rigid: their elasticity with respect to productivity is strictly less than 1.

## Unemployment fluctuations#

This section discusses unemployment fluctuations in the matching model. We first show that the model with rigid wages generates realistic fluctuations in unemployment. We then show that the model with bargained wages is unable to generate such fluctuations. The reason is that bargained wages are too flexible.

#### Lecture videos#

• Shimer (2005) – This paper shows that the textbook matching model of the labor market cannot generate realistic fluctuations in unemployment and vacancies because bargained wages are too flexible.
• Hall (2005) – This paper shows that a matching model with fixed wages can generate large fluctuations in unemployment and vacancies— larger in fact that the fluctuations observed in the United States.
• Hall, Milgrom (2008)) – This paper proposes a form of wage bargaining that produces somewhat-rigid wages. With such bargaining protocol, the matching model generates realistic fluctuations in unemployment and vacancies.

## Frictional and rationing unemployment#

This section turns to the sources of unemployment over the business cycle. We first establish that usual matching models do not have job rationing. That is, all unemployment would disappear in these models if workers searched sufficiently hard. We then develop a matching model with job rationing. In this model, in recession, jobs are lacking, so some unemployment remains even if workers are desperate to find a job. As a result, unemployment can be divided into rationing and frictional components. The frictional component is larger in good times but smaller in bad times.

#### Lecture videos#

• Michaillat (2012) – This paper establishes that usual matching models do not have job rationing and develops a matching model with job rationing. In this model all fluctuations are caused by shocks to labor productivity.
• Michaillat, Saez (2015) – This paper extends the model in Michaillat (2012) by introducing an aggregate demand. Aggregate demand shocks generate fluctuations in unemployment and vacancies along the Beveridge curve.
• Michaillat, Saez (2022) – This paper builds a dynamic version of the model in Michaillat, Saez (2015), which is static. In this model the central bank can influence aggregate demand and unemployment through interest rates.

## Efficient unemployment and unemployment gap#

This section defines and computes the socially efficient rate of unemployment in the matching model. It then extends the analysis to all models with a Beveridge curve—not only the matching model. It finally argues that in the United States unemployment is generally inefficient, and the unemployment gap is countercyclical.

#### Lecture videos#

• Michaillat, Saez (2021) – This paper derives sufficient-statistic formulas for efficient labor market tightness and efficient unemployment rate. It also applies the formulas to the United States.
• Michaillat, Saez (2022) – This paper shows that under simple but realistic assumptions, the sufficient-statistic formula for the efficient unemployment rate reduces to $u^\ast = \sqrt{uv}$.
• Hosios (1990) – This paper shows that in a textbook matching model, unemployment is efficient when workers’ bargaining power equals the elasticity of the matching function with respect to unemployment.

## Labor-demand policies#

Over the business cycle, fluctuations in labor demand generate fluctuations in unemployment that are inefficient. Labor market policies that can influence labor demand should therefore counterbalance these fluctuations and bring the unemployment rate closer to its efficient level. This section discusses how minimum wage, payroll tax, and public employment—all policies that directly influence labor demand—should respond to unemployment fluctuations over the business cycle.

#### Lecture videos#

• Neumark, Shirley (2022) – This survey reviews US evidence on the effect of the minimum wage on employment.
• Michaillat (2014) – This paper obtains the results that in a matching model with job rationing, the public-employment multiplier is positive but less than one, and the multiplier is larger when the unemployment rate is higher.
• Auerbach, Gorodnichenko (2012) – This paper finds that in the United States, government multipliers are larger when the unemployment rate is higher.

## Unemployment insurance#

In the United States, unemployment is more generous in bad times than in good times. This section studies optimal unemployment insurance in a matching model to assess whether such countercyclical generosity is desirable. We discuss the different channels through which unemployment insurance affects the labor market. We then derive a formula for optimal unemployment insurance. We conclude that indeed optimal unemployment insurance is countercyclical.