Working Paper: CEPR ID: DP7075
Authors: Guido Menzio; Espen R. Moen
Abstract: We consider a frictional labor market in which firms want to insure their senior employees against income fluctuations and, at the same time, want to recruit new employees to fill their vacant positions. Firms can commit to a wage schedule, i.e. a schedule that specifies the wage paid by the firm to its employees as function of their tenure and other observables. However, firms cannot commit to the employment relationship with any of their workers, i.e. firms can dismiss workers at will. We find that, because of the firm's limited commitment, the optimal schedule prescribes not only a rigid wage for senior employees, but also a downward rigid wage for new hires. Moreover, we find that, while the rigidity of the wage of senior workers does not affect the allocation of labor, the rigidity of the wage of new hires magnifies the response of unemployment and vacancies to negative shocks to the aggregate productivity of labor.
Keywords: business cycles; competitive search; risk sharing; unemployment
JEL Codes: E24; E32; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| limited commitment by firms (D25) | optimal wage schedule prescribes a rigid wage for senior employees (J31) |
| optimal wage schedule prescribes a rigid wage for senior employees (J31) | allocation of labor for senior workers (J29) |
| optimal wage schedule prescribes a rigid wage for senior employees (J31) | response of unemployment and vacancies to negative shocks in aggregate productivity (J69) |
| falling productivity (O49) | firm maintains efficient hiring wage for junior employees (M51) |
| falling productivity (O49) | firm provides efficient insurance wage for senior employees (J32) |
| falling productivity (O49) | replacing senior employees with new hires (J63) |
| limited commitment by firms (D25) | magnifies the response of unemployment and vacancies to small negative productivity shocks (J69) |
| positive shocks (E32) | do not alter the response of unemployment and vacancies (J69) |