Frictional Unemployment

Frictional unemployment is unemployment that arises from the time it takes for workers to find jobs and for employers to fill vacancies. It is a feature of a dynamic labour market, in which workers move between jobs and firms search for suitable employees.

Definition

Frictional unemployment is the short-term unemployment that results from the process of matching workers and jobs. It is distinct from structural unemployment, which arises from a mismatch between the skills of workers and the requirements of jobs, and from cyclical unemployment, which arises from a deficiency of aggregate demand.

Frictional unemployment is present even when the labour market is in equilibrium, since it takes time for the matching process to occur. It is therefore part of the natural rate of unemployment, the rate at which inflation is stable.

Causes

Frictional unemployment arises from several sources. Workers may leave their jobs voluntarily to search for better ones, and they may spend time searching before accepting an offer. New entrants to the labour market, including graduates, search for their first jobs.

The matching process takes time because information is imperfect and because the characteristics of jobs and of workers are varied. Firms and workers must search for suitable matches, and the search involves costs.

The level of frictional unemployment depends on the efficiency of the matching process. Improvements in information, such as job boards and online platforms, can reduce the time required to match, while barriers to mobility can increase it.

Measurement

Frictional unemployment is difficult to measure directly, since it is defined by the reason for unemployment rather than by an observable characteristic. It is often estimated as the component of unemployment that remains when the labour market is in equilibrium.

The level of frictional unemployment affects the natural rate, and therefore the level of unemployment that is consistent with stable inflation. If frictional unemployment is high, the natural rate is high, and monetary policy must accept a higher level of unemployment to keep inflation stable.

Policy

Policy can reduce frictional unemployment by improving the efficiency of the matching process. Measures include improving information about vacancies, reducing barriers to mobility, and providing assistance with job search.

Policy can also affect frictional unemployment through the design of unemployment benefits. Generous benefits reduce the pressure on the unemployed to accept jobs quickly, which can raise frictional unemployment. The design of benefits must balance the insurance they provide against their effect on the incentive to search.

Consideration must also be given to the duration of unemployment. If frictional unemployment becomes long-term, it may turn into structural unemployment, as skills erode and attachment to the labour market weakens. Measures to prevent this include active labour market policies and training.

Search and Matching

The analysis of frictional unemployment is based on the theory of search and matching, which models the process by which workers and firms find each other. The theory recognises that the matching process takes time and that the outcome depends on the effort of both sides.

The matching function summarises the relationship between the number of matches and the inputs of search, including the number of unemployed workers and the number of vacancies. The function exhibits constant or decreasing returns to scale, and it determines the rate at which matches occur.

The theory distinguishes the job creation decision of firms, which depends on the expected return from a vacancy, and the job acceptance decision of workers, which depends on the wage and on the value of continued search. The equilibrium of the model determines the level of unemployment and of vacancies.

The Beveridge Curve

The Beveridge curve depicts the relationship between the unemployment rate and the vacancy rate. The curve slopes downward, since a tighter labour market, with more vacancies relative to unemployment, is associated with lower unemployment.

Movements along the curve reflect the state of the business cycle. During a recession, the vacancy rate falls and the unemployment rate rises, moving the economy down and to the right along the curve.

Shifts of the curve reflect changes in the efficiency of matching. An increase in frictional unemployment, or a deterioration in the matching process, shifts the curve outward, so that a given vacancy rate is associated with higher unemployment. The outward shift of the Beveridge curve after the financial crisis has been interpreted as evidence of increased mismatch.

Policy and Institutions

Policy can affect frictional unemployment through several channels. The design of unemployment benefits affects the incentive to search, and the level and the duration of benefits determine the replacement rate and the pressure to accept offers.

Active labour market policies, including training, job search assistance, and placement services, can improve the matching process and reduce frictional unemployment. The evidence suggests that these policies can be effective, particularly when they are targeted and when they are combined with monitoring.

The design of employment protection legislation also matters. Strong protection can reduce the rate at which workers enter unemployment, but it can also reduce the rate at which they find new jobs, since firms are more cautious about hiring. The net effect depends on the balance of these two effects.

Summary

Frictional unemployment arises from the time required to match workers and jobs, and it is analysed using the theory of search and matching. Its level depends on the efficiency of the matching process and on the design of labour market institutions, and it affects the natural rate of unemployment.

See also

• Labour Economics
• Okun’s Coefficient
• Output Gap