Sticky Multiple-Price Policies

We develop an information-based model of discrete adjustment in the labor market, in which the firm adjusts to shocks by varying the number of employed workers. Decisions about the firm's employment level are made on the basis of imprecise awareness of current market conditions. Imperfect information is endogenized using a variant of the theory of rational inattention, giving rise to an endogenous adjustment hazard function of the kind posited by Caballero et al (1997). We contrast the predictions of our model with those a labor demand model with full information but physical adjustment costs that can be interpreted as the costs of disruption to production. We conduct a policy experiment in which variation in the tax wedge changes the firm's optimal information acquisition policy, and we use this experiment to differentiate the employment dynamics implied by the information-based model from those implied by the physical adjustment cost model.