LABOR MARKET EQUILIBRIUM WITH REHIRING

Authors

  • JAVIER FERNÁNDEZ-BLANCO

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    • I would like to thank Fabrizio Perri for his guidance and encouragement. I also benefited from discussions with Michele Boldrin, Andrew Cassey, V. V. Chari, Belén Jerez, Larry Jones, Philipp Kircher, Narayana Kocherlakota, Dirk Krueger, Claudio Michelacci, Nicola Pavoni, David Rahman, José-Víctor Ríos-Rull, and Ludo Visschers. Special thanks to Edgar Preugschat for countless comments on this article. Finally, comments from Jan Eeckhout, the editor, and the referees substantially improved this article. I gratefully acknowledge the financial support of the Ramon Areces Foundation as well as Spain's Ministry of Science and Technology under Grant Nos. SEJ2007-63098 and 2011/0031/001. Please address correspondence to: Javier Fernández-Blanco, Department of Economics, University Carlos III of Madrid, Spain. Phone: (34) 91 624 5734. Fax: (34) 91 624 93 29. E-mail: jferna3@eco.uc3m.es.


Abstract

Consistent with the empirical evidence, this article analyzes a labor market in which separations are not permanent and reactivated firms prefer to rehire former employees instead of seek new ones. Workers engage in job search due to the uncertain prospects of rehiring. If firms can commit to wages contingent on rehiring, they backload wages to provide incentives for workers to reduce their unobservable search effort. Under risk aversion and incomplete markets, if productivity at reactivation is sufficiently high, the tension between wage backloading and consumption smoothing leads to excessive search in equilibrium.

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