Long-Term Unemployment and the Great Recession: The Role of Composition, Duration Dependence, and Non-Participation

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1 Long-Term Unemploymen and he Grea Recession: The Role of Composiion, Duraion Dependence, and Non-Paricipaion Kory Krof Fabian Lange Mahew J. Noowidigdo Lawrence F. Kaz Universiy of Torono McGill Universiy Norhwesern Universiy Harvard Universiy and NBER and NBER and NBER Firs Version: May 2013 This Version: June Absrac We explore he exen o which composiion, duraion dependence, and labor force non-paricipaion can accoun for he sharp increase in he incidence of long-erm unemploymen (LTU) during he Grea Recession. We firs show ha composiional shifs in demographics, occupaion, indusry, region, and he reason for unemploymen joinly accoun for very lile of he observed increase in LTU. Nex, using panel daa from he Curren Populaion Survey for , we calibrae a maching model ha allows for duraion dependence in he exi rae from unemploymen and for ransiions beween employmen (E), unemploymen (U), and non-paricipaion (N). We model he job-finding raes for he unemployed and non-paricipans, and we use observed vacancy raes and he ransiion raes from E-o-U, E-o-N, N-o-U, and U-o-N as he exogenous forcing variables of he model. The calibraed model can accoun for almos all of he increase in he incidence of LTU and much of he observed ouward shif in he Beveridge curve beween 2008 and Boh negaive duraion dependence in he job-finding rae for he unemployed and ransiions o and from non-paricipaion conribue significanly o he abiliy of he model o mach he daa afer kory.krof@uorono.ca; fabian.lange@mcgill.ca; noo@alum.mi.edu; lkaz@harvard.edu. We hank Barbara Perongolo for exremely useful and houghful commens as a discussan and David Card, Alex Mas, and Jim Poerba for helpful feedback, and we hank Mark He for excellen research assisance.

2 1 Inroducion This paper invesigaes wheher a search and maching model can explain imporan feaures of he U.S. labor marke in he Grea Recession and is afermah. In paricular, we ask wheher such a model can accoun for he rise in he unemploymen rae and he increase in he incidence of long-erm unemploymen (LTU) among he unemployed. 2 To moivae our analysis, we begin by decomposing he overall unemploymen rae by unemploymen duraion. Figure 1 plos he unemploymen rae for he shor-erm unemployed (<15 weeks), he mediumerm unemployed (15-26 weeks) and he long-erm unemployed (>26 weeks) from 1948 o The shor-erm unemployed ypically represen he vas majoriy of he unemployed wih he shor-erm unemploymen rae around 4 percen in normal imes. The medium- and long-erm unemployed accoun for much less of oal unemploymen, wih raes ypically near 1 percen. During he Grea Recession, unemploymen raes increased across all duraion groups. However, he long-erm unemploymen rae reached record levels and remains hisorically high: unemploymen raes for boh he shor-erm and longerm unemployed were around 3.5 percen in Alhough shor-erm and medium-erm unemploymen raes were roughly back o heir normal pre-recession levels by 2012, long-erm unemploymen remains persisenly high. Anoher way o see his is in Panel A of Figure 2, which shows he share of unemployed workers who are long-erm unemployed among prime-aged workers (aged years). This share increased from around 20 percen in 2008 o roughly 45 percen in Panel B of Figure 2 shows ha he Beveridge curve he relaionship beween unemploymen and job vacancies shifed ouward during he Grea Recession. This paper aemps o accoun for hese wo facs he rise in he LTU share and he shif in he Beveridge curve by exploring he role of shifs in he composiion of he unemployed, duraion dependence in jobfinding raes for he unemployed, and ransiions in and ou of he labor force (beween unemploymen, employmen, and non-paricipaion). To preview our main resul, we find ha an enriched maching model incorporaing duraion dependence and non-paricipaion can accoun for almos all of he increase in he incidence of LTU and mos of he ouward shif in he Beveridge curve during he Grea Recession. By conras, we do no find any evidence ha composiional shifs play an imporan role. We begin our analysis by showing ha beween 2008 and 2013, composiional shifs owards groups wih radiionally longer unemploymen duraions accoun for very lile of he overall rise in he incidence of LTU documened in Figure 2. We show ha LTU increased for virually all groups and ha composiional 2 By incidence of long-erm unemploymen, we mean he share of oal unemployed individuals a a poin in ime who are currenly experiencing long unemploymen duraions (ypically defined as eiher above 26 weeks or 52 weeks). 1

3 shifs do no go very far in accouning for he rise in LTU. For his exercise, composiional shifs refer o changes in observed characerisics of unemployed workers specifically, variables in he Curren Populaion Survey (CPS) relaed o demographics, occupaion, indusry, region, and he reason for unemploymen. We emphasize ha his analysis canno accoun for changes in he composiion of he unemployed along unobserved characerisics. We nex examine he exen o which a maching model along he lines of Morensen and Pissarides (1994) and Shimer (2005) can accoun for he observed increase in LTU and he observed shif in he Beveridge curve. To do his, we enrich a sandard maching model along hree dimensions. Firs, we allow for duraion dependence in he job-finding rae of he unemployed. Second, we allow for flows beween employmen (E), unemploymen (U), and non-paricipaion (N), insead of focusing exclusively on flows beween E and U, as in a sandard maching model. Third, we allow flows from employmen and non-paricipaion ino unemploymen o occur no jus ino shor duraions, bu ino long unemploymen duraions, as well, consisen wih observed flows in he CPS. Our raionale for exploring duraion dependence in he unemployed job-finding rae is based on several recen resume audi sudies which show ha callbacks from employers o se up an inerview decline wih he curren non-employmen duraion on a job applican s resume (Krof, Lange, and Noowidigdo 2013; Eriksson and Rooh 2013; Ghayad 2013). This form of employer discriminaion could arise from human capial depreciaion or employer screening, whereby employers perceive he long-erm unemployed o be less producive employees. Negaive duraion dependence in he job-finding rae could also be due o lower search effor among he unemployed a longer duraions due o discouragemen. Negaive duraion dependence in he exi rae from unemploymen can poenially amplify he effecs of a downurn in he labor marke and increase LTU. According o a recen repor by he Congressional Budge Offi ce (CBO), long-erm unemploymen may produce a self-perpeuaing cycle wherein proraced spells of unemploymen heighen employers relucance o hire hose individuals, which in urn leads o even longer spells of joblessness (CBO 2012). As a resul, negaive duraion dependence in he job-finding rae from unemploymen would appear o be a promising candidae explanaion for undersanding he recen sharp rise increase in LTU. As more workers are pushed ino longer unemploymen spells, negaive duraion dependence lowers he average job-finding rae and hus increases he overall unemploymen rae. Therefore, duraion dependence can poenially explain boh he rise in LTU as well as he observed ouward shif in he Beveridge curve during he Grea Recession, as documened in Elsby, Hobijn, and Sahin (2010). Our raionale for exploring he non-paricipaion margin is moivaed by previous work demonsraing 2

4 he fluid boundary beween non-paricipaion and unemploymen (Clark and Summers 1979; Flinn and Heckman 1983; Card and Riddell 1993; Jones and Riddell 1999; Elsby, Hobijn and Sahin 2013) as well as recen research on he effecs of unemploymen insurance (UI) benefi exensions on ransiions beween unemploymen, employmen, and non-paricipaion (Rohsein 2011; Farber and Valea 2013). The recen UI research finds significan effecs of exended UI in reducing he exi rae from unemploymen o nonparicipaion. The subsanial UI benefi exensions during he Grea Recession may herefore have induced some jobless individuals o coninue o repor hemselves as unemployed in he CPS, conribuing o he observed rise in LTU. Beyond his specific mechanism, we also observe large changes in ransiion raes o and from non-paricipaion since We calibrae our enriched maching model on monhly daa in he years before he Grea Recession ( ), and sudy how well he calibraed model fis he daa during he Grea Recession, holding fixed he calibraed parameers. 3 In our analysis, we implemen a wo-sep empirical approach. In he firs sep, we measure ransiion raes beween he differen labor marke saes (E, U, and N) over he enire period and esimae duraion dependence using daa from In he second sep, we calibrae he maching model parameers. By firs measuring ransiion raes wihou imposing he srucure of he maching model, we obain measured hazard raes (beween unemploymen, employmen, and non-paricipaion) ha are robus o model misspecificaion. 4 An alernaive o our wo-sep approach would be o esimae he hazard raes and he maching model parameers joinly in a single sep. One advanage of our wo-sep approach is ha i clarifies when failures o mach he evoluion of he job-finding raes over his ime period are due o shorcomings in he enriched maching model. Anoher advanage is ha i is sraighforward o impose alernaive assumpions abou he magniude of rue duraion dependence o explore sensiiviy of he resuls (since he second sep akes he duraion dependence esimaes from he firs sep as given, allowing alernaive duraion dependence esimaes o be plugged in a he second sage). In all of our analyses, we rea vacancies, ransiions from employmen o unemploymen and nonparicipaion, and ransiions beween non-paricipaion and unemploymen as he exogenous forcing variables of he model. By conras, we allow he job-finding raes (for boh he unemployed and nonparicipans), he labor marke saes, and he disribuion of unemploymen duraions o all evolve endogenously (holding consan he calibraed parameers from he period). Clearly, a more complee model of he economy would endogenize hese variables. However, we rea hese variables as exogenous 3 The NBER s Business Cycle Daing Commiee daes he beginning of he Grea Recession o be December 2007 and he end o be June The assumpions required o esimae he ransiion raes are laid ou in he Daa Secion and in Appendix B. 3

5 because endogenizing hem would require a model of vacancy creaion as well as a model of labor demand, which is beyond he scope of his paper. In our sensiiviy analysis, we manipulae he vacancy raes ha we use in our counerfacual experimens o examine how he model performs when he srengh of labor demand changes. 5 Summarizing our resuls, we find ha our calibraed model does a very good job of accouning for he increase in he incidence of long-erm unemploymen and can also accoun for much of he observed ouward shif in he Beveridge curve. These conclusions are fairly robus o a variey of alernaive assumpions, such as allowing duraion dependence o vary over he business cycle, as suggesed by he experimenal resuls in Krof, Lange and Noowidigdo (2013). On he oher hand, our model has diffi culy maching he observed relaionship beween vacancies and non-paricipaion during he Grea Recession. In paricular, i predics a job-finding rae for non-paricipans ha is oo high afer Why N-o-E ransiions fell so much more han expeced (and coninue o remain so low hrough 2013) herefore remains an imporan open quesion for fuure work. To undersand he relaive imporance of duraion dependence and changes in (N-o-U, U-o-N, and E- o-n) ransiion raes in he model s abiliy o accoun for he observed increase in LTU and he observed ouward shif in he Beveridge curve, we simulae he calibraed model shuing down each of hese feaures one-by-one. Firs, we shu down duraion dependence by re-calibraing he model under he assumpion ha he job-finding rae is independen of unemploymen duraion. In his scenario, we find ha he model accouns for much less of he rise in LTU and he observed ouward shif in he Beveridge curve. We inerpre his as evidence ha duraion dependence plays an imporan role in accouning for boh of hese phenomena. Second, we shu down he exogenous non-paricipaion flows by fixing hese flows a he values observed a he end of 2007, and we find ha he prediced LTU shares and unemploymen raes boh deviae subsanially from our baseline calibraions. In paricular, he counerfacual predicions show much less of an ouward shif in Beveridge curve. The E-o-N flows are no cenral o his resul, bu U-o-N flows and paricularly N-o-U flows play an imporan role. This closely relaes o resuls in Elsby, Hobijn and Sahin (2013) who find ha he flows from unemploymen o non-paricipaion explain close o one-hird of he cyclical variaion in he unemploymen rae. Overall, our analysis suggess ha changes in he flows from non-paricipaion o unemploymen (specifically, flows ino long-erm unemploymen) play an 5 In oher words, we can force differen vacancy raes on he model and evaluae how i performs quaniaively. This leads us o use he erm forcing variables o describe he exogenous raes in our model. 4

6 imporan role in he increase in he incidence of LTU afer One explanaion for his finding ceners around he very large UI exensions ha ook place during he Grea Recession. Our resuls indicae ha flows from unemploymen o non-paricipaion declined from abou 20 percen monhly in 2008 o abou 14 percen monhly in 2009 and only slowly recovered afer We conjecure ha many unemployed individuals may have remained in unemploymen longer and are now classified as LTU (raher han being classified as non-paricipans). We also speculae ha UI exensions may have played a role in causing many UI recipiens o coninue o consider hemselves as labor force paricipans, even afer many weeks of joblessness. This is consisen wih he empirical findings of Rohsein (2011) and Farber and Vallea (2013). Our counerfacual esimaes sugges ha a large amoun of he increase in unemploymen wih duraions longer han 52 weeks migh be aribuable o he decline in he rae a which he unemployed became non-paricipans. While our calibraed model can accoun for much of he ouwards shif in he Beveridge curve, i does no provide a complee accouning of he shif. Davis, Faberman and Haliwanger (2013) offer a promising explanaion for he residual shif in he Beveridge curve no accouned for by our maching model, which focuses on he vacancy rae raher han he unemploymen rae in he Beveridge curve. They find a reducion in recruiing inensiy and in effecive vacancies, which may indicae coninuing weak labor demand since he Grea Recession. According o heir research, employers are lising vacancies bu are no recruiing workers as inensively o fill hem (as in he recen pas), implicily waiing around for he perfec job candidaes. Our work closely relaes o Elsby e al. (2011), who provide a horough empirical exploraion of longerm unemploymen and non-paricipaion in he Grea Recession. An imporan difference is ha our analysis is primarily based on a quaniaive exploraion of a calibraed maching model. One advanage of our model-based approach is ha we can more readily conduc counerfacual scenarios o assess he relaive imporance of duraion dependence and non-paricipaion in accouning for he observed increase in longerm unemploymen and he observed ouward shif of he Beveridge curve. Our paper is also similar o subsequen research by Krueger, Cramer, and Cho (2014), who build on and exend our maching funcion o allow for differenial effecs by unemploymen duraion wihin he maching funcion and also allow for differenial labor force wihdrawal (i.e., U-o-N ransiions) for he shor-erm and long-erm unemployed. They evaluae wheher he long-erm unemployed exer differenial pressure on wage growh and inflaion. Our work also relaes o Barnichon and Figura (2013), who esimae a sandard maching funcion over he period and find ha he prediced job-finding rae is much lower han he observed jobfinding rae during he Grea Recession. Barnichon and Figura consider a generalized maching funcion 5

7 incorporaing worker heerogeneiy (demographics, reason for unemploymen and duraion of unemploymen) and labor marke segmenaion (geography and occupaion group) and find ha i maches observed job-finding raes during he Grea Recession much more closely. While hey consider a wo-sae model of he labor marke and focuses primarily on job-finding raes, our paper considers a hree-sae model adding non-paricipaion and also focuses more on he incidence of long-erm unemploymen. Lasly, our paper is broadly relaed o an acive lieraure in macroeconomics on he relaive conribuions of inflows ino and ouflows from unemploymen o unemploymen dynamics (Hall 2005; Shimer 2012; Elsby, Michaels and Solon 2009; Fujia and Ramey 2009; Barnichon 2012; Elsby, Hobijn and Sahin 2013). The emerging consensus from his lieraure is ha he ouflow conribuion is a leas 50 percen, bu he lieraure is agnosic as o he facors behind falling ouflows from unemploymen. Our paper conribues o his lieraure by explicily invesigaing wo specific mechanisms behind he fall in he ouflow rae: duraion dependence and ransiions in and ou of he labor force. 6 The remainder of he paper proceeds as follows. Secion 2 describes he daa. Secion 3 invesigaes he role of composiion. Secion 4 describes he maching funcion ha we use o invesigae he role of duraion dependence and non-paricipaion. Secion 5 describes he mehodology for he model calibraion. Secion 6 presens he resuls of he model calibraion. Secion 7 repors he counerfacual scenarios and discusses alernaive explanaions. Secion 8 concludes 2 Daa This secion briefly describes our daa sources. Appendix A provides more deail on he daa used in our analysis. Curren Populaion Survey (CPS). We use monhly CPS daa beween 2002 and 2013 (ending in April 2013), limiing he sample o individuals beween he ages of 25 o 55. We focus on his prime-age sample o enable us o ignore issues of delayed labor force enry of younger workers and changes in reiremen paerns of older workers. We use hese CPS daa in several ways. Firs, we use repeaed cross-secion daa when invesigaing he role of composiion, limiing he sample o unemployed workers. Second, we use boh cross-secion and panel daa (merging individuals across monhs o build panel daa) o invesigae he role of duraion dependence and non-paricipaion. For his exercise, we use daa on all employed, 6 A relaed paper ha akes ino accoun negaive duraion dependence in job-finding raes is Hornsein (2012). Hornsein exends he framework in Shimer (2012) o allow for wo ypes of unemployed workers: hose wih high exi raes from unemploymen (he shor-erm unemployed) and hose wih low exi raes from unemploymen (he long-erm unemployed). The generalized framework is beer able o accoun for long-erm unemploymen during recessions, whereas Shimer s framework wih a homogenous job-finding rae significanly undersaes i. The exended framework also increases he inflow conribuion o unemploymen, relaive o Shimer s sudy. 6

8 unemployed, and non-paricipans. In he cross-secion, we keep rack of he oal populaion of each caegory o esimae he socks. To creae panel daa, we mach observaions across successive monhs, maching on household idenifier, line number, age, gender, and race. We use he mached panel daa in addiion o he CPS cross-secional esimaes of he unemployed, he employed, and non-paricipans o esimae he ransiion raes beween unemploymen, employmen, and non-paricipaion in each monh. We also compue overall (pre-2008) ransiion raes by unemploymen duraion (ino boh employmen and non-paricipaion). Finally, we compue ransiion raes from employmen and non-paricipaion ino unemploymen by unemploymen duraion. Job Openings and Labor Turnover Survey (JOLTS). We use monhly JOLTS daa beween 2002 and 2013 o compue he oal number of vacancies. We use hese vacancy daa o calibrae he maching model below during he pre-2008 period. We hen use he pos-2008 vacancy daa as one of he exogenous forcing variables for our counerfacual scenarios. 3 Long-erm Unemploymen and he Grea Recession: Assessing he Role of Composiion Figure 1 shows ha he share of he labor force ha are long-erm unemployed subsanially increased during he Grea Recession and has remained elevaed. We nex examine he rise in he share of he currenly unemployed wih duraion exceeding 26 weeks and invesigae he role of composiion in accouning for his observed increase. Figure 2 (Panel A) illusraes he dramaic increase in LTU as a share of overall unemploymen. The long-erm share increased from around 20 percen a he beginning of 2008 o roughly 45 percen in Mos of he increase occurred in 2009, a year afer he recession began. Moreover, he share remained elevaed a around 45 percen well afer he recession offi cially ended. By comparison, he recession which began in 2001 saw his share increase from roughly 12 percen o 25 percen. Similar o he Grea Recession, he share increased roughly a year afer he recession began and remained elevaed for several years afer he recession offi cially ended. Neverheless, he Grea Recession was much deeper han he early 2000s downurn, and i had a subsanially larger impac on he srucure of unemploymen duraions. In his secion, we invesigae he exen o which he increase in LTU during he Grea Recession can be accouned for by shifing composiion in observable characerisics of he unemployed. We do his by invesigaing he incidence of long-erm unemploymen, over ime, for several demographic, indusry, occupaion, geographic, and reason-for-unemploymen groups, along wih each group s unemploymen 7

9 share. Panel A of Figure 3 considers he educaion srucure of he unemployed. I shows ha he share of LTU in oal unemploymen is fairly similar across all educaion groups. During he recession, long-erm unemploymen uniformly increased across all educaion groups. Panel B of Figure 3 shows ha high school graduaes are a larger share of he unemployed han college graduaes. During he Grea Recession, here is a small increase in he share of college graduaes among he unemployed. Despie his, since he rae of long-erm unemploymen is fairly fla across all educaion groups, shifs in he educaion srucure of he unemployed canno accoun for he changing unemploymen duraion dynamic during he Grea Recession. Online Appendix Figures OA1 hrough OA7 consider differen observable characerisics. The impac of he Grea Recession was widespread increasing he long-erm unemploymen share in all major demographic groups, indusries, occupaions, geographic regions, and reasons for unemploymen. The long-erm unemploymen share also increased in groups by reason for unemploymen (job losers, hose on emporary layoff, job leavers, new enrans, and re-enrans). To quanify how much composiional shifs overall could have explained he rise in long-erm unemploymen, we hold fix he long-erm unemploymen raes for each group in he pre-2008 period, and invesigae how much observed shifs in group shares can explain he overall rise in long-erm unemploymen. The aggregaed evidence presened in Figure 4 shows ha composiional changes in he unemployed accoun for virually none of he observed rise in long-erm unemploymen. The rise in long-erm unemploymen is found for all major labor marke groups and is no a demographically-isolaed phenomenon. 4 Maching Framework In his secion, we ouline our maching framework, which augmens a sandard maching model o allow for duraion dependence in unemploymen and flows o and from non-paricipaion. We begin wih a sandard maching model of he labor marke (Pissarides 1985; Morensen and Pissarides 1994), which models flucuaions in he job-finding probabiliy hrough a reduced-form maching funcion. We enrich his sandard maching model o allow for duraion dependence in unemploymen and we allow a full se of ransiions beween employmen (E), unemploymen (U), and non-paricipaion (N). 7 Our goal is o calibrae his model using daa from before he Grea Recession and assess how well i accouns for ouflows from unemploymen and non-paricipaion ino employmen beween 2008 and Throughou all of our analysis, we ake he number of vacancies and inflows ino unemploymen and 7 Recen research by Elsby e al. (2011) has highlighed he imporan role played by non-paricipans in undersanding he dynamics of long-erm unemploymen during he Grea Recession. 8

10 non-paricipaion as given. These are he exogenous forcing variables of he model. The endogenous variables are he full disribuion of unemploymen duraions, he populaion shares in each labor marke sae, and he job-finding raes of he unemployed and non-paricipans. To inroduce he model, we begin wih he following noaion: 1. P = populaion size ( is monhly calendar ime), {E, U } = number of employed and unemployed individuals wih associaed raes {e = E P, u = U P }. Noe ha he unemploymen rae is defined relaive o he oal populaion (raher han he labor force), which imposes symmery wih he non-paricipaion rae defined below. 2. N = P E U = number of non-paricipans. Le he size of he labor force be denoed by L = E + U and he non-paricipaion rae by n = N P. 3. V = oal number of job vacancies. The number of job vacancies is an exogenous forcing variable during in he counerfacual scenarios we describe below. 4. Flows o unemploymen: λ EU (employmen unemploymen), λ NU (non-paricipaion unemploymen). Boh of hese ransiion raes are forcing variables during Flows o employmen: λ UE (unemploymen employmen), λ NE (non-paricipaion employmen). These job-finding raes are allowed o endogenously evolve during Flows o non-paricipaion: λ EN (employmen non-paricipaion), λ UN (unemploymen nonparicipaion). Boh of hese ransiion raes are forcing variables during The Appendix provides more deail on how each of hese ransiion raes are compued. 4.1 Labor Marke Flows During he Grea Recession We begin by presening descripive evidence on labor marke flows over ime. Figure 5 plos he monhly ransiion raes o and from employmen, unemploymen, and non-paricipaion. The measured ransiion raes are adjused o be consisen wih observed changes in socks beween monhs; Appendix B provides he deails of his procedure. We also accoun for seasonaliy by residualizing ou monh fixed effecs, and we smooh he series by aking hree-monh moving averages. Firs, we see in Panel A ha he monhly ransiion raes from unemploymen o employmen and non-paricipaion dropped significanly during Saring in 2010, he flows from unemploymen ino non-paricipaion began o recover and by he end of 2013 were close o heir pre-recession levels. On 9

11 he oher hand, he job-finding raes of he unemployed (flows from unemploymen o employmen) have remained low following he Grea Recession. Second, Panel B shows ha flows from employmen o non-paricipaion remained relaively fla during he Grea Recession. Job losses leading o unemploymen (employmen o unemploymen flows) spiked up in he Grea Recession in and have slowly come back down in he recovery. Third, Panel C shows ha job-finding raes of non-paricipans (flows from non-paricipaion o employmen) dropped in 2008 and remained low hrough he end of While he job-finding rae for he unemployed declined sharply and boomed ou in 2009, he job-finding rae for non-paricipans fell more smoohly, and boomed ou in On he oher hand, flows from non-paricipaion o unemploymen increased subsanially in 2008 and remained high unil he end of Ineresingly, in he pre-grea Recession period, he ouflow rae from non-paricipaion o employmen always exceeded he ouflow rae o unemploymen; however, during he Grea Recession and a leas hrough 2013, he opposie was rue. We show below ha accouning for flows from non-paricipaion o unemploymen during he Grea Recession is imporan for undersanding he dynamics of he unemploymen rae. In paricular, we find ha ignoring changes in he N-o-U and U-o-N ransiion raes afer 2008 resuls in a much smaller ouward shif in he Beveridge curve according o our calibraed model. 8 Flows from unemploymen o employmen are in par affeced by flows from unemploymen o nonparicipaion. For example, if more of he unemployed individuals were o wihdraw from he labor force, hese individuals do no go from unemploymen o employmen a he same rae. To explore his issue, we define labor marke flows for indomiable job seekers (Clark and Summers 1979) o be he raio of U-o-E flows o he sum of U-o-E and U-o-U flows. This concepually corresponds o a hypoheical unemployed job seeker who is unable o exi he labor force (and hus can only eiher ransiion o employmen or remain unemployed, perhaps indefiniely). This re-scaled U-o-E ransiion rae is (mechanically) higher for indomiable job seekers as illusraed in Panel D of Figure 5; however, we also see a similarly sharp drop in he job-finding rae for his group during he Grea Recession. 4.2 Maching Funcion We adap he sandard maching funcion o allow non-paricipans o find jobs. We assume ha nonparicipans and unemployed individuals mee job openings according o he funcion M(U + sn, V ) = 8 Addiionally, we discuss below how many individuals flowing from non-paricipaion o unemploymen repor longer unemploymen duraions afer

12 m 0 (U + sn) α V 1 α. 9 One may inerpre s as he share of he non-paricipans ha are marginally aached or alernaively as he search effi ciency of non-paricipans relaive o he unemployed, following Jones and Riddell (1999, 2006). According o heir esimaes, sn is abou percen of he unemployed populaion, and hey also find ha λ UE is roughly wice as large as λ NE. We assume ha he share of meeings wih unemployed individuals is given by U/(U + sn), while he remaining share is wih non-paricipans. In addiion, we assume (for he unemployed) ha he probabiliy ha a meeing resuls in a hire depends on he duraion of unemploymen. In paricular, A(d) gives he relaive hiring probabiliy of an individual wih unemploymen duraion d as compared o a newly unemployed individual (wih duraion d = 0). These assumpions imply ha he job-finding raes for he unemployed and non-paricipans are given, respecively, by he following expressions: λ UE (x ; d) = A(d)m 0 x 1 α (1) λ NE (x ) = sm 0 x 1 α (2) where x = V U +sn is a measure of labor marke ighness and d is he duraion of unemploymen. The parameric specificaion for λ UE (d) assumes ha here is rue duraion dependence in job-finding raes ou of unemploymen; i.e., a genuine causal effec of longer unemploymen duraions on he hazard rae of exi ou of unemploymen (Heckman and Singer 1984). We propose a parameric specificaion for A(d) and esimae his funcion in he pre-grea Recession period, as we describe below. Le he probabiliy densiy and disribuion of ongoing unemploymen duraions be given by θ (d) and Θ, respecively. By inegraing over he duraion disribuion, we ge he average job-finding rae for he unemployed: λ UE (x ) = λ UE λ UE (x ) = m 0 x 1 α (x ; τ)θ (τ)dτ A(τ)θ (τ)dτ λ UE How does a recession affec he unemploymen job-finding rae? In a recession, x falls lowering (x, τ) and hence λ UE (x ). The fall in λ UE (x ) affecs θ (τ) which can feed back ino a lower λ UE (x ) hrough duraion dependence, and consequenly a higher unemploymen rae. 9 Noe ha his equaion is o be inerpreed as a meeing funcion, no a maching funcion. Job meeings are convered ino job maches according o equaions (1) and (2) below. 11

13 Noe ha where A = λ UE λ NE = A s A(τ)θ (τ)dτ. Wih empirical esimaes for A and he job-finding raes, we can solve for λ s = A NE λ UE. The righ-hand side varies wih, bu we assume ha s is ime-invarian, so we can simply ake he average of his expression in he o produce an esimae of s o use in our calibraions. Noe ha we also assume ha boh m 0 and A(d) are ime-invarian: here are no cyclical changes in maching effi ciency or cyclical variaion in he magniude of duraion dependence. We explore alernaive assumpions on how A(d) varies over he business cycle in sensiiviy analysis below, while cyclical variaion in he maching effi ciency parameer is sudied in deail in Sahin e al. (2014). 4.3 Labor Marke Dynamics Given he ransiion raes beween employmen, unemploymen and non-paricipaion, we can express he dynamics of each of hese populaions as follows: ( N +1 = N 1 λ NU U +1 (0) = E θ EU U +1 (d + 1) = U (d) (0)λ EU (1 λ UE E +1 = P U +1 N +1 ) NE λ + E λ EN + U λ UN + N θ (0)λ NU (3) ) (d) λ UN + E θ EU (d)λ EU + N θ NU (d)λ NU (4) In hese dynamic equaions, we have placed cares ("^") above λ NE and UE λ (d) o emphasize ha hese raes are endogenous in our counerfacual simulaions. When we consruc he counerfacual scenarios, we assume ha if non-paricipans move o unemploymen, hey draw an unemploymen duraion from he (empirical) disribuion of unemploymen duraions esimaed from observed N-o-U ransiions (where he empirical disribuion is re-esimaed each quarer for hree unemploymen caegories: [0-6) monhs, [6-12) monhs, and 12 monhs). Similarly, we also accoun for he fac ha a share of enrans ino unemploymen from employmen repor unemploymen duraions of 6 monhs or longer, so when employed workers move ino unemploymen, hey draw an unemploymen duraion from he empirical disribuion of unemploymen duraions (esimaed analogously as for non-paricipans above). These wo empirical disribuions are θ NU (d) and θ EU (d), respecively. Since his share changes over ime and increased during he Grea Recession, we esimae hese disribuions in each year-quarer, and we use his ime-varying disribuion in our counerfacual simulaions. 12

14 In he nex secion, we examine he incidence of long-erm unemploymen and he Beveridge curve. The share of unemployed individuals a calendar ime who have been ou of work longer han τ weeks is given by: LT U τ = U (d) d τ U where U (d) is defined by equaions (3) and (4). We use his as our measure of he share of unemployed individuals who are long-erm unemployed, and we focus on τ = 26 weeks and τ = 52 weeks. When we plo he Beveridge curve, we plo he he oal unemployed individuals as prediced by our model agains he oal observed number of job vacancies, normalizing boh measures by he oal populaion (i.e., U /(E +U +N ) and V /(E +U +N )). Since our maching model focuses on capuring job-finding raes of boh unemployed and non-paricipans, we include he oal populaion raher han he oal labor force in he denominaor. 4.4 Counerfacual Scenarios The goal of our calibraions is o assess how far our enriched maching model can go in accouning for he rise in long-erm unemploymen and he ouward shif in he Beveridge curve during he Grea Recession. We also invesigae he relaionship beween he non-paricipaion rae and he vacancy rae. Our approach is o esimae he model fundamenals during on monhly CPS (panel and pooled cross-secional) daa and hen assess he model by comparing our counerfacual predicions o observed labor marke oucomes during We esimae duraion dependence in he job-finding rae from unemploymen (how λ UE varies wih duraion), he search effeciveness of he marginally aached (s), and he overall maching effi ciency m 0 and maching echnology parameer α. Our model uses as exogenous forcing ( ) variables shifs in labor demand where labor demand is proxied for by V, λ EU, λ EN and shifs ( ) beween unemploymen and non-paricipaion vs. unemploymen, λ UN, λ NU. Thus, we fix he paern of duraion dependence, as refleced in A(d), and we allow he job-finding raes λ UE (d) and λ NE and consequenly he enire disribuion of unemploymen duraions o evolve endogenously during he Grea Recession. Our mehodology follows Shimer (2005) by reaing he separaion raes of employed workers from heir jobs, λ EU and λ EN, as exogenous. Shimer also considers exogenous produciviy shocks in his model which affecs he equilibrium level of vacancies. We do no explicily model he deerminaion of vacancies; raher, we ake a more reduced-form approach and insead rea vacancies as exogenous. Finally, we view flows beween non-paricipaion and unemploymen as being ouside he model since hey may 13

15 reflec facors such as he exension of UI benefis. In erms of predicing he incidence of long-erm unemploymen, we rely on he cross-secional share of workers wih ongoing unemploymen spells exceeding 26 and 52 weeks respecively. For predicing socks of unemploymen, employmen, and non-paricipaion over ime, we use he dynamic equaions above o simulae he model. 5 Calibraion Mehodology We calibrae he model in he following seps: 1. We use daa o esimae { { Θ, λ UN, λ UE (d), λ EN describes how we esimae he ransiion raes λ ij (mached) panel daa componen of he CPS., λ EU, λ NE }, λ NU, V, U, N }. The Appendix from he monhly CPS cross-secions and he 2. An imporan issue is how we allocae flows from non-paricipaion o unemploymen of various duraions. Elsby e al. (2011) show ha roughly 60 percen of he inflows ino unemploymen a repored duraions longer han 1 monh originae from non-paricipaion. I appears ha here are marginally aached workers ha alernae beween unemploymen and non-paricipaion and when hese workers reurn o unemploymen, hey ofen repor a duraion which may include ime since hey separaed from heir las employer, as opposed o duraion of unemploymen spell since las leaving non-paricipaion. Panel A of Figure 6 sheds ligh on his issue by ploing he share of flows from non-paricipaion o unemploymen of a paricular duraion. We see ha in he prerecession period, roughly half of he flows had duraions less han or equal o one monh; however, during he Grea Recession, his share dropped subsanially o around 30 percen. On he oher hand, he share of flows wih duraions longer han 12 monhs increased from roughly 20 percen o over 30 percen. In ligh of his, we collapse he daa quarerly and each quarer we esimae he empirical disribuion of unemploymen duraions ha non-paricipans ransiion ino. Therefore, for our pos-2008 counerfacuals, we use his empirical disribuion for each N-o-U ransiion implied by he dynamic equaions of he model and he observed unemploymen duraions ha he non-paricipans are ransiioning ino. 3. Anoher imporan issue is how we allocae flows from employmen o unemploymen of various duraions. Panel B of Figure 6 plos he share of E-o-U flows going o a given unemploymen duraion. In inerpreing he shares in his figure, noe ha he scale of he lef (righ) axis is for 14

16 duraions less han or equal o (greaer han) one monh. We see ha in he pre-recession period, roughly 80 o 85 percen of he ransiions from employmen o unemploymen repor duraions less han or equal o one monh. However, his share falls o 70 percen during he Grea Recession. We follow analogous procedure as in previous sep, esimaing he empirical disribuion of unemploymen duraions ha employed workers ransiion ino (for each quarer), and we use his disribuion in our counerfacual scenarios for each E-o-U ransiion. 4. We use he measured relaive job finding raes a differen duraions (λ UE (d) ) o esimae A(d). For , we fi a curve hrough he empirical esimaes of λ UE (d), normalized by λ UE (0), using he following funcional form: A(d) = (1 a 1 a 2 ) + a 1 exp( b 1 d) + a 2 exp( b 2 d). See panel A of Figure 7 for our preferred esimae of Â(d). The esimaes repored in Table 1 are â 1 = 0.314, â 2 = 0.393, b1 = and b 2 = We find ha he job-finding rae declines sharply for he firs 8-10 monhs of unemploymen and hen declines much less seeply afer ha. The declining job-finding rae wih duraion of unemploymen can reflec rue negaive duraion dependence in which he longer any individual is unemployed, he lower becomes he job-finding rae. Alernaively, i could reflec heerogeneiy among he unemployed wih he remaining pool of he unemployed being more negaively seleced a longer duraions. To invesigae his, we re-esimae A(d) conrolling for a very rich se of observable characerisics available in he CPS: gender, fifh-degree polynomial in age, hree race caegories (whie/black/oher), five educaion groups (high school dropou, high school graduae, some college, college graduae, advanced degree), and gender ineracions for all of he age, race, and educaion variables. When we conrol for hese observable characerisics, we coninue o find ha he job-finding rae (condiional on observables) declines sharply wih unemploymen duraion; moreover, he esimaed decline is very similar o he resuls from esimaing A(d) wihou conrols, as can be seen by comparing he solid line (wih conrols) o he dashed line (wihou conrols) in Panel A of Figure 7. Of course, hese resuls do no rule ou exisence of unobserved heerogeneiy such as differences in recall raes o one s previous job as documened by Kaz (1986), Kaz and Meyer (1990), and Fujia and Moscarini (2013), which could parially explain he apparen negaive duraion dependence afer conrolling for sandard CPS observables. Addiionally, declining employer percepions of he qualiy of he unemployed a longer unemploymen duraions could also play an imporan role and would be consisen wih recen resume audi sudies finding ha job applicaions wih longer employmen gaps (longer duraion of unemploymen) ge lower callback raes han hose wih implied shorer 15

17 unemploymen duraion (Krof, Lange, and Noowidigdo 2013; Eriksson and Rooh 2013; Ghayad 2013). We noe ha he paern of negaive duraion dependence afer conrolling for he observables in he CPS in panel A of Figure 7 is fairly similar o he resuls of declining employer callback raes wih unemploymen duraion in he audi sudy of Krof, Lange and Noowidigdo (2013), which we also use in alernaive counerfacual scenarios below. In our main resuls, we use he esimaes of A(d) which includes he large se of conrols described above. The resuls of he alernaive duraion dependence esimaes are repored in Table 2. Given he concerns abou A(d) no represening he causal effec of longer unemploymen duraions, we also make adjusmens o A(d) assuming ha, say, 50% of he observe duraion dependence reflecs a genuine causal effec. 5. Nex, we esimae he parameers of he maching funcion by minimizing he disance beween he observed job-finding raes and he job-finding raes implied by he maching funcions using monhly CPS and JOLTS daa for 2002 o The implied job-finding raes for a given parameer vecor (s, m 0, α), aking esimaed parameers of A(d) as given are he following: ( λ UE V (s, m 0, α) = m 0 Ā U + sn ( λ NE V (s, m 0, α) = m 0 s U + sn ) 1 α ) 1 α The minimum disance esimaes are repored in Table 1 and are as follows: α = 0.753, m 0 = 0.435, and ŝ = { 6. Finally, we use V, λ EU, λ EN counerfacual predicions below., λ UN }, λ NU 1/2008 as he exogenous forcing variables o form our 6 Calibraion Resuls 6.1 Prediced Job-Finding Raes During he Grea Recession, average job finding raes declined in par because average unemploymen duraions increased. Panel B in Figure 7 shows wha happened o average job-finding raes due o he increase in duraions by ploing A = A(τ)θ (τ)dτ from 2002 o A is a useful measure of he duraion srucure of unemploymen since is summarizes how he duraion srucure affecs he average job finding rae assuming ha A(d) describes he effec of unemploymen duraion on he job-finding rae. 16

18 We use he esimaed A(d) which conrols for he rich se of observable characerisics available in he CPS (gender, age, race, and educaion). To he exen ha he recession shifed he unemployed owards longer duraions, his will lower A since A (τ) < We see ha saring in 2008, here was a sharp drop in A from around 0.75 o roughly 0.63 (where A(0) is normalized o 1 so ha A(d) can be inerpreed as he relaive job finding rae for high duraions compared o he newly unemployed). This figure herefore shows ha he indirec effec of a drop in marke ighness on he average job-finding rae is quaniaively imporan, and suggess he possibiliy of a prominen role for negaive duraion dependence in he job-finding rae ou of unemploymen in accouning for changes in long-erm unemploymen share as well as ouward shif in Beveridge curve. In panels A and B of Figure 8, we plo he prediced and observed job-finding raes for he unemployed and non-paricipans, respecively. 11 These ransiion raes are he wo key endogenous variables of he model. By consrucion, he prediced raes mach he observed raes in he pre-grea-recession period. During he Grea Recession, we see ha he model does a reasonable job of predicing he job-finding rae for he unemployed; however, non-paricipans were no filling jobs a he rae hey were prediced o during his ime period. This suggess ha here was somehing fundamenally differen abou he Grea Recession in erms of is impac on individuals ou of he labor force ha is a odds wih he behavior of his group in he pre-recession period. We invesigae his issue below. 6.2 Long-erm Unemploymen Panel A in Figure 9 invesigaes how well our calibraed model maches he observed increase in incidence of long-erm unemploymen. The calibraed model fis he daa by consrucion up o he final quarer of From 2008 onwards, we use he job-finding raes for he unemployed and non-paricipans ha are prediced by our model. We label he daa generaed by model as Counerfacual. Panel A of Figure 9 shows ha our model does very well in accouning for he observed increase in share of unemployed ha are long-erm unemployed, when long-erm unemploymen is defined o be >26 weeks. In panel B of Figure 9, long-erm unemploymen is now defined o be >52 weeks. In his case, our model does no do quie as well, alhough i sill accouns for a large share of he acual increase in long-erm unemploymen. The relaively poorer fi for LTU >52 weeks could be parly due o he fac ha he esimaed A(d) which conrols how job-finding probabiliy falls wih unemploymen duraion declines sharply during he firs 10 Noe ha his variable does no include he direc effec of marke ighness on he average job-finding rae hrough he maching funcion; raher, i only includes he mechanical effec of changes in duraion disribuion on average job-finding raes. 11 We refer o he job-finding raes esimaed according o he mehod in Appendix B as observed job finding raes hroughou he ex. 17

19 several monhs and declines much less seeply afer ha. 6.3 Beveridge Curve Panel C of Figure 9 plos he Beveridge curve using unemploymen and vacancy raes, where he denominaor in each case is defined as oal populaion beween ages 25 and 55. We plo wo curves in his figure. The solid curve, labeled Observed, plos he acual unemploymen and vacancy rae in a given quarer. Nex, he doed curve, labeled Counerfacual, plos he prediced unemploymen along wih he observed vacancy rae for he quarers saring wih 2008Q1. The figure shows a significan spike in unemploymen during he firs quarer of A his poin, vacancies were very low compared o he period. However, even as vacancy raes recovered during 2010 and 2011, he number of unemployed declined only very slowly. I seems as if he Beveridge curve has shifed ou. This is a manifesaion of wha has been dubbed he jobless recovery. Overall, we see ha our model also predics an ouward shif in he Beveridge curve during he Grea Recession, alhough by no as much as observed. This is because while our model accouns for he rise in he long-erm unemployed share of oal unemploymen, i somewha under-predics he overall unemploymen rae. 6.4 Non-Paricipaion and Vacancies We nex invesigae he relaionship beween non-paricipaion and vacancy raes. Panel D of Figure 9 is idenical o panel C of Figure 9, excep ha we consider raes of non-paricipaion insead of unemploymen raes (where again he oal populaion P = L + N = E + U + N is he denominaor). Alhough our model does a reasonably good job of describing he relaionship beween unemploymen and vacancies, i does a very poor job of fiing he relaionship beween vacancy and non-paricipaion raes. In paricular, he model subsanially under-predics non-paricipaion raes during he Grea Recession. This is primarily due o he fac ha he prediced job-finding rae for non-paricipans is oo high. 6.5 Alernaive Assumpions Regarding Duraion Dependence Our las sensiiviy analysis examines wheher our resuls are sensiive o using alernaive esimaes of duraion dependence. These resuls are repored in Figure 10 where we compare he prediced increase in LTU defined as share of he unemployed wih ongoing duraions exceeding 26 weeks under several scenarios. In Panel A, we repor resuls which esimae A(d) from he CPS conrolling for a rich se of observables as well as resuls which impose he A(d) funcion which mos closely maches he experimenal 18

20 esimaes in Krof, Lange and Noowidigdo (2013). One of he scenarios uses he experimenal esimaes from he overall sample, while anoher scenario allows A(d) o vary wih he unemploymen rae. In our baseline calibraion we assume ha A(d) is sable over he business cycle, while Krof e al. (2013) presen evidence which suggess ha magniude of duraion dependence is smaller when he unemploymen rae is relaively high. We herefore allow A(d) o vary wih he unemploymen based on experimenal esimaes and calibrae model wih his alernaive assumpion on duraion dependence. Overall, we find ha he predicions are fairly similar across hese scenarios, reflecing he fac ha he esimae of duraion dependence in he CPS (wih and wihou conrols) is fairly similar o he experimenal esimaes in Krof e al. (2013). Nex, in Panel B of Figure 10, we re-scale he CPS esimae of A(d) by assuming ha only a fixed percenage represens rue duraion dependence (i.e., a genuine causal effec of unemploymen duraion on job-finding rae). When we assume ha only 50% of observed duraion dependence is causal, we sill find ha our calibraed model can accoun for a large of he rise in LTU. This is because even in his scenario he job-finding rae sill falls sharply over he firs six monhs of unemploymen. 7 Counerfacual Scenarios 7.1 Ignoring Duraion Dependence We nex demonsrae ha accouning for duraion dependence in job-finding raes is crucial for his success in maching he daa. To do his, we re-esimae he maching model seing A(d) = 1. The resuls of his exercise are repored in Figure 11 where panels A and B repor LTU shares and panels C and D repor he Beveridge curve and he curve relaing non-paricipaion raes o vacancy raes, respecively. Panels A and B show ha he prediced LTU from model calibraion ignoring duraion dependence is much lower han he prediced LTU we ge when accouning for negaive duraion dependence in he exi rae from unemploymen. Thus, duraion dependence in job-finding raes is empirically imporan in undersanding he hisorical increase in LTU during he Grea Recession. Turning o he Beveridge curve in Panel C, we see ha he model does worse when ignoring duraion dependence in erms of predicing he observed unemploymen rae during he Grea Recession. This is clear visual evidence ha a sandard maching model wihou negaive duraion dependence underpredics unemploymen. On he oher hand, Panel D shows ha he magniude of duraion dependence does no subsanially affec prediced non-paricipaion raes, alhough duraion dependence does appear 19