A signaling model of temporary layoffs

Temporary layoffs are an important feature of North American and European labor markets. This article presents an asymmetric information model of layoffs that explicitly considers the possibility of recall. In this model, high-productivity workers are more likely to be recalled to their former employer and may choose to remain unemployed rather than to accept a low-wage job. In this case, unemployment can serve as a signal of productivity. I present conditions under which all equilibria satisfying the Cho-Kreps intuitive criterion must entail (some) unemployment. Because of productivity gains from valuable job-matches, unemployment may be socially desirable for those workers who were particularly productive with their former employer. If so, a re-employment bonus that encourages low-productivity workers to find a new job but does not discourage high-productivity workers from waiting for recall is an optimal policy from societal perspective. Equity properties of such a policy and its cost effectiveness are analysed. © Oxford University Press 2009 All rights reserved.