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Labor Market Dynamics under Long Term Wage Contracting

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Author Info
Leena Rudanko

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Abstract

This paper introduces risk averse workers into a search and matching model and considers the quantitative performance of the model over the business cycle. Wages are determined by long term contracts between workers and firms, with firms providing insurance to workers against variation in labor productivity. The insurance motive delivers endogenous wage rigidity, the extent of which depends on the contracting environment. The quantitative results show that the model has no trouble producing wages that are too rigid relative to data. The key parameter governing how much volatility the model produces not only in unemployment and vacancies but also wages, is the drop in consumption for the unemployed. In addition, explaining the volatility of wages requires that contracting is limited by the ability of both the worker and firm to end the employment relationship unilaterally. These results contrast with Shimer (2005) and Hall (2005), who argue for introducing rigid wages into search and matching models.

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Publisher Info
Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 314.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:314

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Related research
Keywords: business cycles; unemployment; wage rigidity; search;

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Find related papers by JEL classification:
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
J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

References listed on IDEAS
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. Marcus Hagedorn & Iourii Manovskii, 2008. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," American Economic Review, American Economic Association, vol. 98(4), pages 1692-1706, September. [Downloadable!]
    Other versions:
  2. Mark Aguiar & Erik Hurst, 2005. "Consumption versus Expenditure," Journal of Political Economy, University of Chicago Press, vol. 113(5), pages 919-948, October.
  3. Beaudry, Paul & DiNardo, John, 1991. "The Effect of Implicit Contracts on the Movement of Wages over the Business Cycle: Evidence from Micro Data," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 665-88, August. [Downloadable!] (restricted)
  4. Caplin, Andrew S & Spulber, Daniel F, 1987. "Menu Costs and the Neutrality of Money," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 703-25, November. [Downloadable!] (restricted)
    Other versions:
  5. Raj Chetty, 2008. "Moral Hazard vs. Liquidity and Optimal Unemployment Insurance," NBER Working Papers 13967, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Christopher A. Pissarides, 2007. "The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?," CEP Discussion Papers dp0839, Centre for Economic Performance, LSE. [Downloadable!]
  7. Browning, Martin & Crossley, Thomas F., 2001. "Unemployment insurance benefit levels and consumption changes," Journal of Public Economics, Elsevier, vol. 80(1), pages 1-23, April. [Downloadable!] (restricted)
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  8. Sigouin, Christian, 2004. "Self-enforcing employment contracts and business cycle fluctuations," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 339-373, March. [Downloadable!] (restricted)
  9. Melvin Stephens, 2001. "The Long-Run Consumption Effects Of Earnings Shocks," The Review of Economics and Statistics, MIT Press, vol. 83(1), pages 28-36, February. [Downloadable!] (restricted)
  10. MacLeod, W Bentley & Malcomson, James M, 1993. "Investments, Holdup, and the Form of Market Contracts," American Economic Review, American Economic Association, vol. 83(4), pages 811-37, September. [Downloadable!] (restricted)
  11. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December. [Downloadable!] (restricted)
  12. Leena Rudanko, 2008. "Aggregate and Idiosyncratic Risk in a Frictional Labor Market," Boston University - Department of Economics - Working Papers Series wp2008-009, Boston University - Department of Economics. [Downloadable!]
  13. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March. [Downloadable!] (restricted)
  14. Bils, Mark J, 1985. "Real Wages over the Business Cycle: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 93(4), pages 666-89, August. [Downloadable!] (restricted)
  15. Darren Grant, 2003. "The effect of implicit contracts on the movement of wages over the business cycle: Evidence from the national longitudinal surveys," Industrial and Labor Relations Review, ILR Review, ILR School, Cornell University, vol. 56(3), pages 393-408, April. [Downloadable!] (restricted)
  16. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
    Other versions:
  17. Robert E. Hall & Paul R. Milgrom, 2008. "The Limited Influence of Unemployment on the Wage Bargain," American Economic Review, American Economic Association, vol. 98(4), pages 1653-74, September. [Downloadable!]
    Other versions:
  18. James Ted McDonald & Christopher Worswick, 1999. "Wages, Implicit Contracts, and the Business Cycle: Evidence from Canadian Micro Data," Journal of Political Economy, University of Chicago Press, vol. 107(4), pages 884-913, August. [Downloadable!] (restricted)
    Other versions:
  19. Baily, Martin Neil, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Blackwell Publishing, vol. 41(1), pages 37-50, January. [Downloadable!] (restricted)
  20. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March. [Downloadable!]
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. Shigeru Fujita & Garey Ramey, 2005. "The Dynamic Beveridge Curve," University of California at San Diego, Economics Working Paper Series 2005-08, Department of Economics, UC San Diego. [Downloadable!]
    Other versions:
  2. Jonathan P Thomas & Tim Worrall, 2007. "Limited Commitment Models of the Labour Market," Keele Economics Research Papers KERP 2007/11, Centre for Economic Research, Keele University. [Downloadable!]
    Other versions:
  3. Leena Rudanko, 2008. "Aggregate and Idiosyncratic Risk in a Frictional Labor Market," Boston University - Department of Economics - Working Papers Series wp2008-009, Boston University - Department of Economics. [Downloadable!]
  4. Robert Shimer, 2006. "Mismatch," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
    Other versions:
  5. Renato Faccini & Salvador Ortigueira, 2008. "Labor-Market Volatility in the Search-and-Matching Model: The Role of Investment-Specific Technology Shocks," Economics Working Papers ECO2008/39, European University Institute. [Downloadable!]
  6. Guido Menzio & Espen Moen, 2008. "Worker Replacement," PIER Working Paper Archive 08-040, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
    Other versions:
  7. Enchuan Shao & Pedro Silos, 2007. "Uninsurable individual risk and the cyclical behavior of unemployment and vacancies," Working Paper 2007-05, Federal Reserve Bank of Atlanta. [Downloadable!]
  8. Giulio Fella, 2007. "Optimal Severance Pay in a Matching Model," Working Papers 07-02, Utrecht School of Economics. [Downloadable!]
    Other versions:
  9. Per Krusell & Toshihiko Mukoyama & Ayseg ul Sahin, 2007. "Labor-Market Matching with Precautionary Savings and Aggregate Fluctuations," Levine's Bibliography 122247000000001783, UCLA Department of Economics. [Downloadable!]
    Other versions:
  10. Christopher A. Pissarides, 2007. "The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?," CEP Discussion Papers dp0839, Centre for Economic Performance, LSE. [Downloadable!]
  11. Burcu Eyigungor, 2008. "Specific capital and vintage effects on the dynamics of unemployment and vacancies," Working Papers 08-6, Federal Reserve Bank of Philadelphia. [Downloadable!]
  12. Christian Haefke & Marcus Sonntag & Thijs van Rens, 2007. "Wage Rigidity and Job Creation," Economics Working Papers 1047, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2008. [Downloadable!]
    Other versions:
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