We propose a theory of self-fulfilling unemployment fluctuations. When a firm increases its workforce, it raises demand and weakens competition facing other firms, as employed workers spend more and have less time to search for low prices than unemployed workers. These effects induce other firms to hire more labor in order to scale up their presence in the product market. The feedback between employment and product market conditions generates multiple equilibria—and the possibility of self-fulfilling fluctuations—if differences in shopping behavior between employed and unemployed are large enough. Evidence on spending, shopping, and prices suggests that this is the case.
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