Unemployment and Endogenous Reallocation over the Business Cycle

This paper presents a tractable stochastic general equilibrium model in which to study different types of unemployment over the business cycle. In our model workers face search frictions on their local labor markets and reallocation frictions across labor markets. The interaction of these two types of frictions is shown to have important implications for the analysis of resource allocation over the business cycle. We focus attention on (i) the impact on the aggregate unemployment rate, and its decomposition into search, rest, reallocation and job separation components; (ii) the expected duration of unemployment; and (iii) how the interaction between search and reallocation frictions affects the cyclicality of job separations and worker reallocations over the business cycle. We use this framework to quantitatively assess the relative contributions of the different sources of unemployment in explaining the unemployment rate and its cyclical properties.