Reference Dependence and Labor Market Fluctuations

Kfir Eliaz, Ran Spiegler

Chapter in NBER book NBER Macroeconomics Annual 2013, Volume 28 (2014), Jonathan A. Parker and Michael Woodford, editors (p. 159 - 200)
Conference held April 12-13, 2013
Published in April 2014 by University of Chicago Press
© 2014 by the National Bureau of Economic Research
in NBER Book Series NBER Macroeconomics Annual

We incorporate reference-dependent worker behavior into a search-matching 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 Köszegi 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).

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This paper was revised on June 4, 2013

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Document Object Identifier (DOI): 10.1086/674596

This chapter first appeared as NBER working paper w19085, Reference-Dependence and Labor-Market Fluctuations, Kfir Eliaz, Rani Spiegler
Commentary on this chapter:
  Comment, Robert E. Hall
  Comment, Giuseppe Moscarini
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