We document a new mechanism for which cyclical variation in the unemployment rate reduces the aggregate level of output and welfare. Our mechanism concerns the earnings losses generated by job displacement. It has been broadly established that this type of earnings losses are large. We rely on the empirical results of Davis and von Wachter (2011) who document that both the frequency of job displacement and the earnings losses per displaced worker are increasing in the unemployment rate. This implies that aggregate earnings losses are convex in the unemployment rate. We model the above phenomenon in a general equilibrium framework which accounts for heterogeneity on both the firm and worker side. We quantify the effect of business cycles and find that they reduce GDP by 1.5%.
Using Triolith we have obtained a tentative baseline calibration of the model but extensive robustness exercises remains to be done. We also intend to write a follow-up paper using the same model.