Discussion paper

DP13263 Hysteresis via Endogenous Rigidity in Wages and Participation

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 produc-
tivity, (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.


López-Salido, J (2018), ‘DP13263 Hysteresis via Endogenous Rigidity in Wages and Participation‘, CEPR Discussion Paper No. 13263. CEPR Press, Paris & London. https://cepr.org/publications/dp13263