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Labor Market Dynamics under Long Term Wage Contracting

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  • Leena Rudanko

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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Bibliographic 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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Keywords: business cycles; unemployment; wage rigidity; search;

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References

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  1. Martin Browning & Thomas Crossley, 1996. "Unemployment Insurance Benefit Levels and Consumption Changes," Department of Economics Working Papers 1996-01, McMaster University.
  2. Christopher A. Pissarides, 2009. "The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?," Econometrica, Econometric Society, vol. 77(5), pages 1339-1369, 09.
  3. Michael Reiter, 2006. "Embodied technical change and the fluctuations of wages and unemployment," Economics Working Papers 980, Department of Economics and Business, Universitat Pompeu Fabra.
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  5. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
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  9. Haefke, Christian & Sonntag, Marcus & van Rens, Thijs, 2008. "Wage Rigidity and Job Creation," IZA Discussion Papers 3714, Institute for the Study of Labor (IZA).
  10. Christian Sigouin, 2000. "Self-enforcing Employment Contracts and Business Cycle Fluctuations," Cahiers de recherche CREFE / CREFE Working Papers 127, CREFE, Université du Québec à Montréal.
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  12. Marianna Kudlyak, 2011. "The cyclicality of the user cost of labor with search and matching," Working Paper 09-12, Federal Reserve Bank of Richmond.
  13. Leena Rudanko, 2010. "Aggregate and Idiosyncratic Risk in a Frictional Labor Market," Boston University - Department of Economics - Working Papers Series WP2010-054, Boston University - Department of Economics.
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  19. Sigouin, Christian, 2004. "Self-enforcing employment contracts and business cycle fluctuations," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 339-373, March.
  20. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
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  25. 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.
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