Endogenous Labor Force Participation, Involuntary Unemployment and Monetary Policy

Abstract

This paper develops a New Keynesian model with search frictions in which generated frictional unemployment is consistent with the time series of involuntary unemployment collected by the U.S. Bureau of Labor Statistics. Thus, it can shed light on the relevant impact of labor market frictions and policy interventions on the observed unemployment about which policy makers and the public are concerned. The data-consistent unemployment is achieved in the model via introduction of partial consumption insurance and an endogenous labor force participation channel. In particular, I find that allowing for endogenous labor force participation greatly improves the model fit for U.S. data. It appears that the price markup shock and matching efficiency shock are the two key driving forces of unemployment fluctuations. Monetary policy that stabilizes the participation gap can be welfare improving.