Reservation wages and the wage flexibility puzzle

Koenig, Felix, Manning, Alan and Petrongolo, Barbara (2014) Reservation wages and the wage flexibility puzzle. CEP Discussion Papers, CEPDP1319. Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Abstract

Wages are only mildly cyclical, implying that shocks to labour demand have a larger short-run impact on unemployment rather than wages, at odds with the quantitative predictions of the canonical search and matching model. This paper provides an alternative perspective on the wage flexibility puzzle, explaining why the canonical model can only match the observed cyclicality of wages if the replacement ratio is implausibly high. We show that this failure remains even if wages are only occasionally renegotiated, unless the persistence in unemployment is implausibly low. We then provide some evidence that part of the problem comes from the implicit model for the determination of reservation wages. Estimates for the UK and West Germany provide evidence that reservation wages are much less cyclical than predicted even conditional on the observed level of wage cyclicality. We present evidence that elements of perceived “fairness” or “reference points” in reservation wages may address this model failure.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://cep.lse.ac.uk/_new/publications/series.asp?...
Additional Information:	© 2014 The Authors
Library of Congress subject classification:	H Social Sciences > HD Industries. Land use. Labor
Journal of Economic Literature Classification System:	E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E24 - Macroeconomics: Employment; Unemployment; Wages; Intergenerational Income Distribution (includes wage indexation) J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs > J31 - Wage Level and Structure; Wage Differentials by Skill, Training, Occupation, etc. J - Labor and Demographic Economics > J6 - Mobility, Unemployment, and Vacancies > J64 - Unemployment: Models, Duration, Incidence, and Job Search
Sets:	Research centres and groups > Centre for Economic Performance (CEP)
Identification Number:	CEPDP1319
Funders:	Economic and Social Research Council (ESRC)
Date Deposited:	06 Jan 2015 14:55
URL:	http://eprints.lse.ac.uk/60613/

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