Working Paper: NBER ID: w29937
Authors: Guido Menzio
Abstract: I study a search equilibrium model of the labor market in which workers have stubborn beliefs about their labor market prospects, i.e. beliefs about their probability of finding a job and the wage they will earn that do not respond to aggregate fluctuations in fundamentals. I show that, when workers have stubborn beliefs, the response of the wage bargained by a firm and a worker to aggregate shocks is dampened. As a result, the response of labor market tightness, job-finding probability, unemployment and vacancies to aggregate fluctuations is amplified. I show that stubborn beliefs generate cyclical inefficiencies in the labor market that can be corrected with countercyclical employment subsidies. I find that the response of the labor market to negative shocks is the same even if only a small fraction of workers has stubborn beliefs. In contrast, if the fraction of workers with stubborn beliefs is small, the response of the labor market to positive shocks is approximately the same as under rational expectations.
Keywords: No keywords provided
JEL Codes: E03; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stubborn beliefs (Z12) | dampened wage responses (J39) |
| dampened wage responses (J39) | amplified labor market tightness (J49) |
| dampened wage responses (J39) | amplified job-finding probabilities (J68) |
| dampened wage responses (J39) | amplified unemployment (J68) |
| dampened wage responses (J39) | amplified vacancies (J68) |
| stubborn beliefs (Z12) | amplified labor market tightness (J49) |
| stubborn beliefs (Z12) | amplified job-finding probabilities (J68) |
| stubborn beliefs (Z12) | amplified unemployment (J68) |
| stubborn beliefs (Z12) | amplified vacancies (J68) |