DP13263 Hysteresis via Endogenous Rigidity in Wages and Participation

Author(s): Cynthia L Doniger, J David López-Salido
Publication Date: October 2018
Keyword(s): hysteresis, Jobless, Kinked Labor Supply, monopsony, Real Rigid- ity, strategic complementarity
JEL(s): D83, E24, J42
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=13263

We document that the past three "jobless" recoveries also featured asymmetries in labor force participation and labor compensation, with each falling to new lows during each cycle. We model these asymmetries as resulting from a strategic complementarity in firms' wage setting and workers' job search strategies. Strategic complementarity results in a continuum of possible equilibria with higher-wage equilibria welfare dominating lower-wage equilibria. Assuming that no economic agent deviates from an existing strategy unless deviation is a unilateral best response, the model exhibits (1) periods of endogenous rigidity in wages and participation, (2) persistent changes in wages, participation, and output in response to transitory movements in labor productivity, (3) sluggish recoveries including both a "jobless" phase, in which productivity recovers while unemployment remains elevated, and a "wageless" phase, in which employment recovers but wages remain depressed. Calibrating the model suggests that the U.S. unemployment rate may need to fall to as low as 2.8 percent before labor compensation recovers to pre-Financial Crisis levels.