The Scarring Effect of Asymmetric Business Cycles
Domenico Ferraro and
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Domenico Ferraro: Arizona State University
Giuseppe Fiori: North Carolina State University
No 283, 2018 Meeting Papers from Society for Economic Dynamics
The employment-to-population ratio in the United States features a marked cyclical asymmetry: deviations below trend (troughs) are larger than deviations above trend (peaks). This asymmetry generates a “scarring effect,” which reduces the average level of the employment-to-population ratio around which the economy fluctuates. To quantify this scar, we build an equilibrium business cycle model featuring search frictions and a labor force participation choice. The model, parametrized to match key observations of U.S. data, including gross worker flows between employment, unemployment, and nonparticipation, generates the observed cyclical asymmetry in the face of symmetric aggregate shocks. We quantify that the employment-to-population ratio would be 0.3 percentage points higher (or, equivalently, a gain of about a million jobs) in the absence of business cycles. Further, by dampening cyclical fluctuations, countercyclical stabilization policy can reduce the job loss by 70%.
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