Furloughs, Employment, and Worker Reallocation in Normal Times

Are furlough schemes useful under normal business cycle conditions? We address this ques- tion using administrative data from Finland, where such a scheme has long existed, and a model of firm dynamics with hiring and layoff costs, frictional unemployment, and firm-level wage rigidity. Furloughs provide firms with flexibility by allowing temporary workforce re- ductions at a lower cost than layoffs followed by rehiring. Yet in the model, it is optimal to eliminate the furlough option, as it does little to facilitate reallocation from low productivity to high productivity firms and does not reduce layoffs much. In contrast, a small layoff tax improves welfare by balancing employment gains against reduced productivity