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Title: Worker Replacement

Author(s): Guido Menzio and Espen R Moen

Publication Date: December 2008

Keyword(s): Business Cycles, Competitive Search, Risk Sharing and Unemployment

Programme Area(s): International Macroeconomics and Labour Economics

Abstract: We consider a frictional labor market in which firms want to insure their senior employees against income fluctuations and, at the same time, want to recruit new employees to fill their vacant positions. Firms can commit to a wage schedule, i.e. a schedule that specifies the wage paid by the firm to its employees as function of their tenure and other observables. However, firms cannot commit to the employment relationship with any of their workers, i.e. firms can dismiss workers at will. We find that, because of the firm's limited commitment, the optimal schedule prescribes not only a rigid wage for senior employees, but also a downward rigid wage for new hires. Moreover, we find that, while the rigidity of the wage of senior workers does not affect the allocation of labor, the rigidity of the wage of new hires magnifies the response of unemployment and vacancies to negative shocks to the aggregate productivity of labor.

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Bibliographic Reference

Menzio, G and Moen, E. 2008. 'Worker Replacement'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7075