Working Papers

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 argue that noise shocks, which capture agents’ expectational errors due to the noise in received signals about the persistence of aggregate productivity, can 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 7 quarters earlier in the absence of noise shocks in the 1968-2019 period. I then 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 model calibrated to target standard moments and disciplined to match impulse responses identified through SVAR does substantially better compared to a model without imperfect information and noise shocks. It generates 23 percent more volatility in unemployment and vacancies and 6 quarters longer recoveries in unemployment, mainly through two channels. First, responses to productivity shocks become 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 source of persistence, which are amplified through on-the-job search and firms' vacancy posting decisions.

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 a significant impact on their job search effort. Pessimistic workers who expect the labor market to do worse in the future 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. Using the 2016 US Presidential election as an exogenous shock to macroeconomic sentiments, I find that Republican states became optimistic immediately after the elections and reported a decline in search hours by 3.75 hours/week relative to the Democrat states that became pessimistic about the economy. The paper evaluates the effect of an expansionary corporate tax cut policy by introducing workers with heterogeneous beliefs in a stylized search model with endogenous search effort. Presence of heterogeneous beliefs dampens the effect of such a policy on the unemployment rate by about 0.7 percentage points as compared to the model with homogeneous and unbiased beliefs.

This paper uses daily data on household expectations to examine what causes households to adjust their expectations about the future of the economy. We analyze several macro variables of policy interest and find that households respond primarily to movements in the unemployment rate. Further, these responses are non-linear and asymmetric, with households displaying higher sensitivity to larger shocks and to negative information indicating a worsening of the economy. We also find heterogeneity across local labor markets: Households in areas with higher local unemployment are more sensitive to changes in national unemployment than those in areas with lower local unemployment. We further examine whether the media plays a role in influencing household expectations, and find that news about unemployment rises sharply during a recession, consistent with the response of expectations.