Worker heterogeneity, selection, and employment dynamics in the face of aggregate demand and pandemic shocks

In a new Keynesian model with random search in the labor market, endogenous selection among heterogeneous workers amplifies fluctuations in unemployment and results in excess unemployment volatility relative to the efficient allocation. Recessions disproportionately affect lowproductivity workers, whose unemployment spells are inefficiently frequent and long. We consider a COVID recession resulting from a negative demand shock and a surge in exogenous separations. Highproductivity workers benefit if separations in a pandemic take the form of temporary layoffs, but this is not true for low-productivity workers. The unemployment consequences are especially severe when nominal interest rates are close to the effective lower bound.