The Financial Channel of Wage Rigidity

04 November 2015
12:30  - 13:30

Benjamin Schoefer, UC Berkeley

Why do fi rms cut hiring so sharply in recessions?  I propose that wage rigidity among incumbent workers forces firms to reduce hiring by squeezing their internal funds.  Incumbents' wage rigidity is an irrelevant fixed cost in standard macroeconomic models, which instead rely on wage rigidity among new hires.  But much empirical evidence indicates that the wages of new hires, unlike those of incumbents, display little rigidity. I integrate financial constraints and incumbents' wage rigidity - but flexible wages among new hires - into the Diamond-Mortensen-Pissarides matching model.  The interaction between these two frictions helps the calibrated model account for more than half of hiring fluctuations in the U.S. data.  My empirical analyses support the fi nancial channel of wage rigidity.  I present new fi rm-level evidence that employment responds to cash flow shocks, and that internal funds help firms stabilize employment during recessions.  Moreover, I calculate that a slight increase in incumbents' wage procyclicality could smooth aggregate pro fits and internal funds.

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