The Cyclical Behavior of Unemployment and Wages under Information Frictions

Camilo Morales-Jimenez
2017 Finance and Economics Discussion Series  
I propose a new mechanism for sluggish wages based on workers' noisy information about the state of the economy. Wages do not respond immediately to a positive aggregate shock because workers do not (yet) have enough information to demand higher wages. Firms, who have perfect information, do not reveal their information and instead extract an informational rent. This increases firms' incentives to post more vacancies, which makes unemployment volatile and sensitive to aggregate shocks. The
more » ... te shocks. The model is robust to two major criticisms of existing theories of sluggish wages and volatile unemployment: flexibility of wages for new hires and procyclicality of the opportunity cost of employment. Calibrated to U.S. data, the model explains 60% of overall unemployment volatility. In line with empirical evidence, the response of unemployment to TFP shocks is large, hump-shaped, and peaks one year after the TFP shock, while the response of the aggregate wage is weak and delayed, peaking after two years. In line with empirical evidence, this model predicts a reallocation of employment from low to high-paying firms during expansions. I show that this reallocation is intensified by sluggish wages, and has significant effects on newly-hired workers as they find more and better paying jobs in booms. * I am especially grateful to Boragan Aruoba and Luminita Stevens for their valuable suggestions and support.
doi:10.17016/feds.2017.047 fatcat:iewhlzry2jcs7n2slptbluz55e