Reference-Dependence and Labor-Market Fluctuations

Kfir Eliaz, Rani Spiegler

NBER Working Paper No. 19085
Issued in May 2013
NBER Program(s):   EFG   LS

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 Kőszegi 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)).

This paper was revised on June 5, 2013

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w19085

Published: Reference Dependence and Labor Market Fluctuations, Kfir Eliaz, Ran Spiegler. in NBER Macroeconomics Annual 2013, Volume 28, Parker and Woodford. 2014

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