DP16499 The Financial Channel of Wage Rigidity

Author(s): Benjamin Schoefer
Publication Date: August 2021
Date Revised: September 2021
Keyword(s):
JEL(s):
Programme Areas: Labour Economics, Public Economics, Financial Economics, Monetary Economics and Fluctuations, Organizational Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16499

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.