Research

The unemployment rate remains persistently high after recessions even after job losses subside. Standard search and matching models have difficulty capturing this pattern. In this paper, I provide new evidence that noise shocks, which capture agents’ expectational errors due to the noise in received signals about the persistence of aggregate productivity, generate substantial persistence in the unemployment rate. I first identify these noise shocks using a novel structural VAR and find that unemployment would have recovered to its pre-recession level six quarters earlier in the absence of noise shocks in the 1968-2019 period. To understand these findings, I set up a general equilibrium search and matching model with on-the-job search, endogenous search effort and wage rigidity and consider three shocks: a permanent productivity shock; a transitory productivity shock and a noise shock. The presence of imperfect information and noise shocks allows the model to match the longer unemployment recovery than in a full information setting. The results point to the importance of imperfect information in explaining the slow recoveries, through two channels. First, responses to persistent productivity shocks are more persistent as it takes time for agents to learn whether a shock is persistent or not. Second, noise shocks provide an additional source of persistence, which are amplified through sticky wages, on-the-job search and firms’ vacancy posting decisions.

This paper investigates what information households use when forming expectations and finds that unemployment shocks, rather than inflation shocks, play the dominant role. Using daily data, we study which macroeconomic announcements cause households to adjust their expectations. We build a model to isolate the unanticipated component of announcements and generate two shock series, assuming households are either sophisticated or naive. We demonstrate that labor market information significantly influences not only households’ subjective expectations about the economy but also their inflation expectations. Even in periods when unemployment is declining and inflation is rising, shocks to unemployment lead to significant adjustments in households’ subjective expectations. Most changes in inflation expectations are driven by shocks to unemployment rather than inflation. Finally, during negative supply and demand shocks, unemployment emerges as the primary driver of household expectations.

Households’ expectations about future economic conditions can play an important role in their job search behavior. Using survey data this paper finds that workers’ expectations for the economy have significant impact on their search effort. Pessimistic workers who expect the future labor market to do worse, significantly increase their current search intensity, while optimistic workers report a decrease. The paper evaluates the effect of an expansionary corporate tax cut policy by introducing workers with heterogeneous beliefs to a stylized search model with endogenous search effort. The presence of heterogeneous beliefs dampens the effect of such a policy on the unemployment rate.