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Incomplete Information, Risk Shifting, and Employment Fluctuations

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  • Herschel I. Grossman

Abstract

This paper explores one of the ways in which acceptance of the hypothesis that labor market transactions involve arrangements for shifting risk from workers to employers strengthens the case for accepting the hypothesis that incomplete information is the critical factor in producing the positive effect of aggregate demand for output on aggregate employment. The analysis shows that the introduction of risk-shifting arrangements into models of incomplete information eliminates the dependence of the relation between aggregate demand and aggregate employment on the relative strengths of the usual substitution and income effects on labor supply of perceived real wage rates or perceived real interest rates. In addition, the analysis shows that the apparent fact that workers choose an amount of risk shifting that gives them constant nominal wage rates implies that incomplete information would produce a positive effect of aggregate demand on aggregate employment. The key to these results is that risk shifting allows workers to use the value of product associated with high levels of demand to supplement the income associated with low levels of demand. Consequently, they can choose high employment instates of high demand without causing a corresponding reduction in their expected marginal utility of consumption.
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Suggested Citation

  • Herschel I. Grossman, 1981. "Incomplete Information, Risk Shifting, and Employment Fluctuations," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 48(2), pages 189-197.
    • Handle: RePEc:oup:restud:v:48:y:1981:i:2:p:189-197.
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    File URL: http://hdl.handle.net/10.2307/2296879
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    Cited by:

    1. Grossman, Herschel I., 1983. "The natural-rate hypothesis, the rational-expectations hypothesis, and the remarkable survival of non-market-clearing assumptions," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 19(1), pages 225-245, January.
    2. John Haltiwanger, 1982. "Specific CApital, Long Term Implicit Contracts, and Temporary Layoffs," UCLA Economics Working Papers 245, UCLA Department of Economics.
    3. Haltiwanger, John, 1984. "The Distinguishing Characteristics of Temporary and Permanent Layoffs," Journal of Labor Economics, University of Chicago Press, vol. 2(4), pages 523-538, October.
    4. Herschel I. Grossman, 1986. "Rationalité, monnaie et activité," Revue de l'OFCE, Programme National Persée, vol. 15(1), pages 207-216.

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