2013-05 | February 2013
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On the Importance of the Participation Margin for Market Fluctuations
Conventional analyses of cyclical fluctuations in the labor market ascribe a minor role to the labor force participation margin. In contrast, a flows-based decomposition of the variation in labor market stocks reveals that transitions at the participation margin account for around one-third of the cyclical variation in the unemployment rate. This result is robust to adjustments of data for spurious transitions, and for time aggregation. Inferences from conventional, stocks-based analyses of labor force participation are shown to be subject to a stock-flow fallacy, neglecting the offsetting forces of worker flows that underlie the modest cyclicality of the participation rate. A novel analysis of history dependence in worker flows demonstrates that a large part of the contribution of the participation margin can be traced to cyclical fluctuations in the composition of the unemployed by labor market attachment.
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