Revisiting the Hypothesis of High Discounts and High Unemployment

Ludo Visschers, Paolo Martellini, Guido Menzio

Research output: Working paper

Abstract

We revisit the hypothesis that cyclical fluctuations in unemployment are caused by shocks to the discount rate. We use a rich search-theoretic model of the labor market in which the UE, EU and EE rates are all endogenous. Analytically, we show that an increase in the discount rate lowers the UE rate and, under some natural conditions, it lowers the EU rate. Quantitatively, we show that an increase in the discount rate from 4 to 10% generates a 3.5% decline in the UE rate and a 6% decline in the EU rate. The response of the unemployment rate is minuscule. These findings are at odds with the actual behavior of the US labor market over the business cycle, which features a negative comovement between the UE and EU rates and large unemployment fluctuations. We show that aggregate productivity shocks generate the correct comovement between the UE and EU rates, as well as large unemployment fluctuations.
Original languageEnglish
PublisherEdinburgh School of Economics Discussion Paper Series
Number of pages37
Publication statusPublished - Jun 2020

Keywords

  • unemployment fluctuations
  • discount rate
  • human capital
  • lifecycle earnings

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