The Financial Channel of Wage Rigidity
I propose a financial channel of wage rigidity. In recessions, rather than propping up marginal (new hires’) costs of labor, rigid average wages squeeze cash flows, forcing firms to cut hiring due to financial constraints. Indeed, empirical cash flows and profits would turn acyclical if wages were only moderately more procyclical. I study this channel in a search and matching model with financial constraints and rigid wages among incumbent workers, while new hires’ wages are flexible. Individually, each feature generates no amplification. By contrast, their interaction can account for much of the empirical labor market fluctuations—breaking the neutrality of incumbents’ wages for hiring, and showing that financial amplification of business cycles requires wage rigidity.
First update of previous, 2015 dissertation, version. I thank my dissertation advisors Raj Chetty, Emmanuel Farhi, Lawrence Katz, and Jeremy Stein. I dedicate this paper to the memory of Emmanuel Farhi. For outstanding research assistance, I thank Tiziano Di Biase, Leonel Drukker, Victoria de Quadros, and Yinjie Yu. For valuable comments, I also thank Nittai Bergman, Gabriel Chodorow-Reich, Tomaz Cajner, Steve Davis, Mark Gertler, Edward Glaeser, Gita Gopinath, Robert Hall, Simon Jäger, Marianna Kudlyak, Matteo Maggiori, Yusuf Mercan, Claudio Michelacci, Kurt Mitman, Luigi Pistaferri, Vincenzo Quadrini, Frank Schilbach, Petr Sedláček, and Andrei Shleifer. I thank the UC Berkeley Clausen Center and Institute for Research on Labor and Employment for financial support. I thank audiences at Chicago Booth School of Business, MIT Sloan, Harvard, Harvard Business School, Berkeley, Copenhagen Business School, London School of Economics, Stockholm IIES, Zurich, the European Central Bank, the Federal Reserve Board of Governors, University of Southern California, the CSEF- EIEF-SITE Conference on Finance and Labor, the 13th Joint ECB/CEPR Labour Market Workshop, and the SED Meeting 2016. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.