Labor Market Flows and Equilibrium Search Unemployment

This paper explicitly differentiates between unemployment and inactivity, by defining inactivity\nas a state in which individuals do not search for jobs when non-employed. Facing changes in\nthe value of inactivity, individuals transit through three labor market states. In steady-state,\nwe hence have a theory of equilibrium unemployment determined by both matching frictions\nand labor market participation margins. The paper firstly rationalizes and quantitatively\naccounts for the existence of large flows between employment, unemployment and inactivity.\nSecondly, it shows that unemployment and aggregate wages rise because some of the\nemployed workers are unattached to the labor force, in the sense that they join the inactive\npool when they lose a job. Thirdly, unemployment income has little effects on employment,\nsince it attracts people into the labor force and rises the share of attached workers. Finally,\nour theory suggests that contrary to two-state models, taxation of market activity increases\nnon-participation, unattachment and adversely affects unemployment.