Labor market dynamics with endogenous labor force participation and on-the-job search

Abstract

Studies that incorporate endogenous labor force participation and search and matching frictions in a real business cycle model report that the model generates counterfactual dynamics: (1) Labor force participation is very volatile and strongly procyclical; (2) Unemployment is weakly procyclical or acyclical; (3) Unemployment and vacancies are positively correlated. To improve the model׳s performance, I enrich the model with on-the-job search as a mechanism to dampen the movements of participation and keep vacancy creation high for longer periods. The proposed model successfully generates weakly procyclical participation, strongly countercyclical unemployment, and the Beveridge Curve. The model also succeeds in matching the statistics for labor force participation and job-to-job flows.