Working Paper: NBER ID: w13674
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 of frictional 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., the interest rate, the value of leisure, and statistics of labor market turnover). Various independent data sources suggest that actual 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 versions, 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. In particular, the last generation of models with on-the-job search appears promising.
Keywords: frictional wage dispersion; search models; quantitative assessment; labor markets
JEL Codes: E24; J24; J31; J6; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| search frictions (F12) | wage dispersion (J31) |
| mean-min ratio (C29) | wage dispersion (J31) |
| observed wage dispersion (J31) | model predictions (C59) |
| risk aversion (D81) | wage differentials (J31) |
| stochastic wage fluctuations (J29) | wage differentials (J31) |
| on-the-job search (J68) | wage differentials (J31) |
| standard model (C20) | wage dispersion (J31) |