What Determines the "Reservation Wage" of Unemployed Workers?

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...reservation wages decline at a modest rate over the unemployment spell...

The pace at which unemployed workers adjust their reservation wage — the lowest wage they will accept at a new position — over a spell of unemployment is a potentially central determinant of whether, and how quickly, they find a job. Despite this, evidence on the behavior of reservation wages over the spell of unemployment remains scarce. It often relies on cross-sectional data, which may be biased by the differences in the composition and search behavior of the pools of unemployed workers with spells of different lengths. In A Contribution to the Empirics of Reservation Wages (NBER Working Paper No. 19870), Alan Krueger and Andreas Mueller examine reservation wage patterns using high-frequency longitudinal data on self-reported reservation wages for a sample of 6,025 unemployment insurance recipients in New Jersey. Reservation wages appear to be of some consequence: workers are 24 percentage points more likely to accept an offer that is equal to or exceeds their reservation wage than to accept a job with a wage below the threshold.

Self-reported reservation wages decline at a modest rate over the unemployment spell, with point estimates ranging from 0.05 to 0.14 percent per week of unemployment. After a year of unemployment, the reservation wage is only 2.5 to 7 percent lower than at the start of the unemployment spell. The decline in reservation wages is driven primarily by individuals over the age of 51, for whom the cost of accepting a lower-paying job is less than the cost for those who plan to spend more time in the labor market, and individuals with personal savings of more than $10,000, who revise their reservation wage downward as they exhaust their assets. There is no evidence of a decline in reservation wages for those who rely exclusively on unemployment insurance benefits for income support, even when benefits are about to expire.

The results suggest that a sizable proportion of individuals are reluctant to reduce their reservation wage despite extended spells of unemployment. Relative to a calibrated job search model, the reservation wage of unemployed workers starts out too high and declines too slowly. This is consistent with many workers persistently misjudging their prospects, and with reservation wages "anchored" on previous wages.

-- Claire Brunel