Working Paper: CEPR ID: DP18019
Authors: Almut Balleer; Georg Duerncker; Susanne Forstner; Johannes Goensch
Abstract: Recent research documents mounting evidence for sizable and persistent biases in individual labor market expectations. This paper incorporates subjective expectations into a general equilibrium labor market model and studies the implications of biased expectations for wage bargaining, vacancy creation, worker flows and labor market policies. Importantly, we find that under the widely used period-by-period Nash bargaining protocol, the model generates a counterfactual relationship between workers' job separation expectations and wages. Instead, a wage setting process with less frequent wage renegotiations is found to be empirically consistent. Moreover, we show that the presence of biased beliefs can qualitatively alter the equilibrium effects of labor market policies. Lastly, when allowing for biased firms' beliefs, we establish that only the difference between firms' and workers' biases matters for the bargained wage but not the size of biases.
Keywords: subjective expectations; labor markets; search and matching; bargaining; policy
JEL Codes: E24; J64; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| pessimistic bias in workers' separation expectations (J63) | higher bargained wages (J52) |
| higher bargained wages (J52) | perceived job separation risk (J63) |
| optimistic job finding expectations (J68) | higher wages (J39) |
| optimistic job finding expectations (J68) | increased unemployment (J65) |
| difference in biases between firms and workers (J79) | bargained wage (J52) |
| biased expectations (D91) | different equilibrium outcomes (D50) |
| biased expectations (D91) | qualitative change in equilibrium effects of labor market policies (J48) |