ABSTRACT
In this chapter, we add flow into and out of the labour market to the standard search-and-matching model to endogenize the aggregate labour force flows across different market states. In our framework, workers are heterogeneous with respect to home productivity, which will drive some of them out of the labour market. Furthermore, labour market conditions are stochastic, in that during good times the expected payoffof searching is higher relative to the value of home production, while in bad times the reverse is true. Therefore, agents in this model have to optimize the usage of time among the trade-offbetween employment, job search and home production. The stochastic nature of the model, with heterogeneous agents, can drive the flow of the labour force in and out of the market, thus generating additional variability of labour force participation and unemployment in the standard model. Qualitatively, we show that these flows into and out of labour markets are increasing in market-dependent state premiums (the capital gains (losses) from the switch of the aggregate state from bad to good (from good to bad); that is, the extra amount of payoffs to the agents whose market status is not changed. Specifically, functions (14) and (15) define its value), like wage payments, net searching income, but decreasing in non-market-dependent state premiums, say home productivity. We also show that, even under the assumption of risk neutral workers prefer persistent participation decisions when the shocks are transient, and flows in and out of the market are smaller than the case of persistent shocks. A quantitatively calibrated model shows that we can increase the standard deviations in variables such as participation, employment and unemployment and generate well-behaved time series to replicate the stylized facts in the labour market. This occurs because in addition to the standard variability of employment and unemployment there is now variability in the size of the market. In the set-up of this chapter, in comparing with the benchmark model calibrated by Shimer (2005), these in and out of market labour force flows account for more than 90 per cent of all variability in unemployment.
