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Employment fluctuations with downward wage rigidity: the role of moral hazard

  • James Costain


    (Banco de España)

  • Marcel Jansen


    (Universidad Carlos III de Madrid)

This paper considers a dynamic matching model with imperfectly observable worker effort. In equilibrium, the wage distribution is truncated from below by a no-shirking condition. This downward wage rigidity induces the same type of inefficient churning and "contractual fragility" as in Ramey and Watson (1997). Nonetheless, the surprising lesson of our analysis is that workers' shirking motive reduces the cyclical fluctuations in job destruction, because firms are forced to terminate some marginal jobs in booms which they cannot commit to maintain in recessions. This time-inconsistency problem casts doubt upon the importance of inefficient churning as an explanation of observed employment fluctuations. On the other hand, the no-shirking condition implies that firms' share of surplus is procyclical, 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. Furthermore, unlike most models with endogenous job destruction, we obtain a robust Beveridge curve.

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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0632.

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Length: 46 pages
Date of creation: Nov 2006
Date of revision:
Handle: RePEc:bde:wpaper:0632
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