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Employment Fluctuations with Downward Wage Rigidity: The Role of Moral Hazard

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Author Info
Costain, James () (Banco de Espana)
Jansen, Marcel () (Universidad Carlos III de Madrid)

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Abstract

This paper studies the cyclical dynamics of Mortensen and Pissarides' (1994) model of job creation and destruction when workers' effort is not perfectly observable, as in Shapiro and Stiglitz (1984). An occasionally-binding no-shirking constraint truncates the real wage distribution from below, making firms' share of surplus weakly procyclical, and may thus amplify fluctuations in hiring. It may also cause a burst of inefficient firing at the onset of a recession, separating matches that no longer have sufficient surplus for incentive compatibility. On the other hand, since marginal workers in booms know firms cannot commit to keep them in recessions, they place little value on their jobs and are expensive to motivate. For a realistic calibration, this last effect is by far the strongest; even a moderate degree of moral hazard can eliminate all fluctuation in the separation rate. This casts doubt on Ramey and Watson's (1997) "contractual fragility" mechanism, and means worker moral hazard only makes the "unemployment volatility puzzle" worse. However, moral hazard has potential to explain other labor market facts, because it is consistent with small but clearly countercyclical fluctuations in separation rates, and a robust Beveridge curve.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 4344.

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Length: 45 pages
Date of creation: Aug 2009
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Handle: RePEc:iza:izadps:dp4344

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Related research
Keywords: job matching; shirking; efficiency wages; endogenous separation; contractual fragility;

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Find related papers by JEL classification:
C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Norikazu Tawara, 2008. "No-shirking Conditions in Frictional Labor Markets," Economics Bulletin, Economics Bulletin, vol. 10(1), pages 1-10. [Downloadable!]
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