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Reference Dependence and Labor Market Fluctuations

In: NBER Macroeconomics Annual 2013, Volume 28

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  • Kfir Eliaz
  • Ran Spiegler

Abstract

We incorporate reference-dependent worker behavior into a search-matching model of the labor market, in which firms have all the bargaining power and productivity follows a log-linear AR(1) process. Motivated by Akerlof (1982) and Bewley (1999), we assume that existing workers’ output falls stochastically from its normal level when their wage falls below a "reference point", which (following Kőszegi and Rabin (2006)) is equal to their lagged-expected wage. We formulate the model game-theoretically and show that it has a unique subgame perfect equilibrium that exhibits the following properties: existing workers experience downward wage rigidity, as well as destruction of output following negative shocks due to layoffs or loss of morale; newly hired workers earn relatively flexible wages, but not as much as in the benchmark without reference dependence; market tightness is more volatile than under this benchmark. We relate these findings to the debate over the “Shimer puzzle” (Shimer (2005)).

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  • Jonathan A. Parker & Michael Woodford, 2014. "NBER Macroeconomics Annual 2013, Volume 28," NBER Books, National Bureau of Economic Research, Inc, number park13-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 12938.

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    Cited by:
    1. Kfir Eliaz & Ran Spiegler, 2014. "Managing Intrinsic Motivation in a Long-Run Relationship," Discussion Papers 1414, Centre for Macroeconomics (CFM).
    2. Rosato, Antonio, 2013. "Selling Substitute Goods to Loss-Averse Consumers: Limited Availability, Bargains and Rip-offs," MPRA Paper 47168, University Library of Munich, Germany.
    3. Holger Herz & Dmitry Taubinsky, 2013. "Market experience is a reference point in judgments of fairness," ECON - Working Papers 128, Department of Economics - University of Zurich.
    4. David Freeman, 2013. "Revealed Preference Foundations of Expectations-Based Reference-Dependence," Discussion Papers dp13-10, Department of Economics, Simon Fraser University.
    5. Eliaz, Kfir & Spiegler, Rani, 2012. "Reference Dependence and Labor-Market Fluctuations," CEPR Discussion Papers 8997, C.E.P.R. Discussion Papers.
    6. Vincent Boitier, 2013. "The Unemployment Volatility Puzzle: a Note on the Role of Reference Points," Working Papers hal-00878107, HAL.

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