Understanding Fluctuations in the Ins and Outs of the Labor Force

Although the size of the labor force is nearly acyclical, worker flows between employment and unemployment on the one hand and inactivity on the other hand fluctuate significantly over the business cycle. After reviewing these facts, this paper lays out a job-search model to uncover the determinants of worker flows between employment, unemployment and inactivity. However rudimentary, the proposed model reproduces the value of these flows across cycles remarkably well. The model further shows that, if aggregate conditions are not a first-order determinant of workers’ labor force decisions, then a substantial part of the observed fluctuations in the ins and outs of the labor force can be attributed to two composition effects. First, workers who join the labor force irrespective of the business cycle are more likely to find themselves immediately unemployed rather than employed when the aggregate job-finding rate is below trend. Hence the countercylicality of the probability to move from inactivity into unemployment. Second, high-productivity workers who are less likely to drop from the labor force are more numerous to be drawn into unemployment in times of high job destruction. They thereby contribute to the fall in the probability to leave the labor force from unemployment during recessions. Both mechanisms are supported by microdata from the Current Population Survey