Macroeconomics — Unemployment as Stocks and Flows

Macroeconomics — The Unemployment Rate Is a Stock, but Its Causes Are Flows

Chapter 2 set out the denominator of the unemployment rate. This chapter looks at how the number of unemployed builds up. Every month many people lose jobs while many others find them. The unemployment rate settles where these two flows balance. Looking at the flows shows that the same rise in unemployment can have different causes.

1. The steady-state unemployment rate

Suppose that each month a fraction $s$ of the employed $E$ lose their jobs (the separation rate) and a fraction $f$ of the unemployed $U$ find jobs (the job-finding rate). For the number of unemployed to stay constant, inflows must equal outflows: $sE=fU$. Dividing by the labour force $L=E+U$ gives

With 20 million employed and a monthly separation rate of 2%, 400,000 people become unemployed each month. If 1 million unemployed find jobs with a monthly probability of 40%, 400,000 people also find work each month. Hundreds of thousands of people move in and out of unemployment each month, but the total stays at 1 million.

In recessions it is mainly $f$ that falls. With the same 2% separation rate, if the job-finding rate falls to 20%, the steady-state rate becomes $0.02/0.22\approx 9.1\%$, almost double. The average duration of unemployment ($1/f$) also rises from 2.5 to 5 months.

2. The Beveridge curve

Firms’ vacancies and the unemployed exist side by side. The curve that plots their relationship is the Beveridge curve.

• Movement along the curve: when the economy weakens, firms hire less, vacancies fall and unemployment rises. This is demand-deficient unemployment.
• Shift of the curve: if there are many vacancies and many unemployed, jobs and job seekers do not match. This is structural unemployment from growing mismatch across skills, regions and industries.

3. Institutions and flows

There is no need to view longer job search due to unemployment benefits as bad in itself: instead of rushing into an ill-suited job, people can find more productive matches. The direction and size of the effect are for the data to judge.

4. Efficiency wages and wait unemployment

Some firms pay wages above the market-clearing level, because higher wages reduce turnover, elicit effort and attract good applicants (efficiency wages). Wages then do not fall, so even in equilibrium more people want jobs than there are jobs. Unemployment may look voluntary, but it is really a queue of people waiting for good jobs.

Check your understanding

What is the steady-state unemployment rate in an economy with a monthly separation rate of 1.5% and a job-finding rate of 30%? $0.015/0.315\approx 4.8\%$. If a recession cuts the job-finding rate to 15%, it becomes $0.015/0.165\approx 9.1\%$. If instead the separation rate doubles to 3% while the job-finding rate stays at 30%, the rate is $0.03/0.33\approx 9.1\%$ — the same unemployment rate, but a completely different labour market with short spells and many people moving in and out.

References

• Christopher Pissarides, Equilibrium Unemployment Theory (2000)
• Robert Shimer, “Reassessing the Ins and Outs of Unemployment,” Review of Economic Dynamics (2012)
• N. Gregory Mankiw, Macroeconomics, ch. 7
• Statistics Korea, Economically Active Population Survey (Korean)