Labor Supply and Frictions over the Business Cycle

This paper analyzes a business cycle model with labor market frictions as well as an extensive labor supply margin. There are exogenous aggregate shocks to productivity, the job finding rate, and the separation rate. Workers also face idiosyncratic productivity (wage) shocks that they cannot insure against directly. The calibrated model reproduces the cyclical properties of employment, unemployment, and labor force participation. Moreover, it delivers aggregate flows across the three worker states - employed, unemployed, and not in the labor force - that are broadly consistent both with the long-run and the cyclical properties of the data. We assess the importance of each individual shock in accounting for various cyclical properties of the labor market. Though the approach taken here leaves open what causes the aggregate shocks, it emphasizes that the data can be successfully replicated with a rather standard-looking model as long as it features both the labor supply channel and the frictional channel.