Working Paper: NBER ID: w29201
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.
Keywords: wage rigidity; financial constraints; labor market fluctuations; search and matching model
JEL Codes: E2; G3; J01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| wage rigidity (J31) | fluctuations in firms' cash flows (D25) |
| fluctuations in firms' cash flows (D25) | firms' hiring capacity (J23) |
| wage rigidity (J31) | firms' hiring capacity (J23) |
| wage cyclicality (J31) | financial stability (G28) |
| smaller labor shares (J49) | smoother cash flows (D25) |
| smaller labor shares (J49) | less volatile employment and investment (J69) |