Economic migration and business cycles in a small open economy with matching frictions

Abstract

With the free movement of labour in Europe, economic migration has become an important determinant of labour supply. Cyclical migration exceeds one percent of the population in many countries and affects (un)employment and wage setting. The main contribution of this paper is that it models migration as an endogenous decision in a search-and-matching framework, where labour market institutions play an important role. It shows that, contrary to typical beliefs, migration can amplify business cycles. After a positive shock to the economy, immigration increases the labour force and initially unemployment. The latter reduces a worker's outside option in wage negotiations, resulting in a lower wage increase than when there is no migration. With cheaper labour firms post more job vacancies, which increases the probability that unemployed workers find jobs and attracts new workers to immigrate. Attenuated response of wages and the stronger response of employment to shocks result in a flatter Phillips curve.