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Worker Replacement

  • Guido Menzio

    ()

    (Department of Economics, University of Pennsylvania)

  • Espen Moen

    ()

    (Department of Economics, Norwegian School of Management (NSM))

We consider a frictional labor market in which firms want to insure their senior employees against income fluctuations and, at the same time, want to recruit new employees to fill their vacant positions. Firms can commit to a wage schedule, i.e. a schedule that specifies the wage paid by the firm to its employees as function of their tenure and other observables. However, firms cannot commit to the employment relationship with any of their workers, i.e. firms can dismiss workers at will. We find that, because of the firm’s limited commitment, the optimal schedule prescribes not only a rigid wage for senior employees, but also a downward rigid wage for new hires. Moreover, we find that, while the rigidity of the wage of senior workers does not affect the allocation of labor, the rigidity of the wage of new hires magnifies the response of unemployment and vacancies to negative shocks to the aggregate productivity of labor.

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File URL: http://economics.sas.upenn.edu/system/files/working-papers/08-040.pdf
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 08-040.

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Length: 37 pages
Date of creation: 01 Sep 2008
Handle: RePEc:pen:papers:08-040
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  1. Martin Neil Baily, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 37-50.
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  15. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-80, March.
  16. Ramey, Garey, 2008. "Exogenous vs. Endogenous Separation," University of California at San Diego, Economics Working Paper Series qt0qb196qd, Department of Economics, UC San Diego.
  17. 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 665-688, August.
  18. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
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