Employment Fluctuations with Downward Wage Rigidity: The Role of Moral Hazard

Authors


  • We thank W. den Haan, J. F. Jimeno, D. Mortensen, G. Ramey, M. Ravn, R. Shimer, J. P. Rincón Zapatero, two anonymous referees, and many seminar participants for their comments. Financing from Spanish institutions (Consolider-Ingenio 2010, SEJ2006-05710, SEC2002-01601, Excelecon, and the Bank of Spain) is gratefully acknowledged. Opinions expressed here are those of the authors, and do not necessarily reflect those of the Bank of Spain or the Eurosystem.

Abstract

We study the cyclical dynamics of job creation and destruction when workers' effort is not perfectly observable. The no-shirking constraint may amplify fluctuations in hiring by making firms' surplus share procyclical, and may cause a burst of inefficient firing when a downturn begins. But quantitatively, it mainly raises the cost of motivating marginal workers in booms, since firms cannot commit to keep them in recessions, and thereby strongly damps the countercyclical fluctuations in the separation rate. This implies a robust Beveridge curve, but casts doubt on Ramey and Watson's (1997)“contractual fragility” mechanism and worsens Shimer's (2005a)“volatility puzzle”.

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