Working Paper: CEPR ID: DP5935
Authors: Andreas Hornstein; Per Krusell; Giovanni L. Violante
Abstract: Standard search and matching models of equilibrium unemployment, once properly calibrated, can generate only a small amount offrictional wage dispersion, i.e., wage differentials among ex-ante similar workers induced purely by search frictions. We derive this result for a specific measure of wage dispersion---the ratio between the average wage and the lowest (reservation) wage paid. We show that in a large class of search and matching models this statistic (the 'mean-min ratio') can be obtained in closed form as a function of observable variables (i.e., interest rate, value of leisure, and statistics of labour market turnover). Looking at various independent data sources suggests that, empirically, residual wage dispersion (i.e., inequality among observationally similar workers) exceeds the model's prediction by a factor of 20. We discuss three extensions of the model (risk aversion, volatile wages during employment, and on-the-job search) and find that, in their simplest version, they can improve its performance, but only modestly. We conclude that either frictions account for a tiny fraction of residual wage dispersion, or the standard model needs to be augmented to confront the data.
Keywords: mean-min ratio; search; wage dispersion
JEL Codes: E24; J31; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| job finding rates (J68) | mean-min ratio of wage dispersion (J31) |
| separation rates (J12) | mean-min ratio of wage dispersion (J31) |
| value of non-market time (D46) | mean-min ratio of wage dispersion (J31) |
| calibration of model parameters (C51) | wage dispersion (J31) |
| frictions (D74) | residual wage dispersion (J31) |
| canonical model modifications (C59) | wage dispersion (J31) |