Reference dependence and labor market fluctuations

Research output: Contribution to journalArticlepeer-review

Abstract

We incorporate reference- dependent worker behavior into a searchmatching model of the labor market, in which firms have all the bargaining power and productivity follows a log- linear AR(1) process. Motivated by Akerlof (1982) and Bewley (1999), we assume that existing workers' output falls stochastically from its normal level when their wage falls below a "reference point," which (following Koszegi and Rabin 2006) is equal to their lagged- expected wage. We formulate the model game- theoretically and show that it has a unique subgame perfect equilibrium that exhibits the following properties: existing workers experience downward wage rigidity, as well as destruction of output following negative shocks due to layoffs or loss of morale; newly hired workers earn relatively flexible wages, but not as much as in the benchmark without reference dependence; market tightness is more volatile than under this benchmark. We relate these findings to the debate over the "Shimer puzzle" (Shimer 2005).

Original languageEnglish
Pages (from-to)159-200
Number of pages42
JournalNBER Macroeconomics Annual
Volume28
Issue number1
DOIs
StatePublished - 2013

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

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