This paper considers a dynamic matching model with imperfectly observable worker effort as in Shapiro and Stiglitz (1994). In our economy the no-shirking condition endogenously imposes real wage rigidity on the matching market. This generates "contractual fragility" and inefficient separations as in Ramey and Watson (1997). Nonetheless, our main finding is that imperfectly observable effort smoothes job destruction over the cycle. The reason is that firms are forced, in good states, to terminate some marginal jobs that they cannot commit to maintain in bad states. This time-inconsistency problem casts doubts on the importance of inefficient churning as an explanation of observed employment fluctuations. On the other hand, the no-shirking condition implies that the surplus share of firms is pro-cyclical, which can amplify fluctuations in job creation. Thus, our model is consistent with recent evidence that job creation is more important than job destruction in driving labor market fluctuations, and it therefore also tends to generate a robust Beveridge curve.
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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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