NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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
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