Working Paper: CEPR ID: DP16499
Authors: Benjamin Schoefer
Abstract: I propose a financial channel of wage rigidity. In recessions, rather than propping up marginal (new hires') costs of labor, rigid average wages squeeze cash flows, forcing firms to cut hiring due to financial constraints. Indeed, empirical cash flows and profits would turn acyclical if wages were only moderately more procyclical. I study this channel in a search and matching model with financial constraints and rigid wages among incumbent workers, while new hires' wages are flexible. Individually, each feature generates no amplification. By contrast, their interaction can account for much of the empirical labor market fluctuations--breaking the neutrality of incumbents’ wages for hiring, and showing that financial amplification of business cycles requires wage rigidity.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| rigid average wages among incumbent workers (J39) | reduced cash flows (G32) |
| reduced cash flows (G32) | limited firms' capacity to hire (J23) |
| rigid average wages among incumbent workers (J39) | limited firms' capacity to hire (J23) |
| increase in procyclicality of wages (E24) | average reduction in incumbent wages by 15 percentage points when unemployment rises by 1 percentage point (F66) |