A Matching Model of Non-Employment and Wage Pressure

In this paper a matching model with variable search intensity that incorporates the inactive is developed and calibrated. The model is used to look at possible explanations for the recent sharp decline in the UK working-age unemployment rate, which has been accompanied by only a moderate reduction in the working-age inactivity rate. From the range of different shocks considered, the most plausible combination consists of a significant reduction in unemployment benefits, perhaps reflecting reduced coverage, coupled with an increase in the student population. According to the model, these shocks would not have produced an increase in aggregate wage pressure.