Reservation wages and the wage flexibility puzzle

Felix Koenig, Alan Manning and Barbara Petrongolo

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Wages are only mildly cyclical, implying that shocks to labour demand have a larger short-run impact on unemployment rather than wages, at odds with the quantitative predictions of the canonical search and matching model. This paper provides an alternative perspective on the wage flexibility puzzle, explaining why the canonical model can only match the observed cyclicality of wages if the replacement ratio is implausibly high. We show that this failure remains even if wages are only occasionally renegotiated, unless the persistence in unemployment is implausibly low. We then provide some evidence that part of the problem comes from the implicit model for the determination of reservation wages. Estimates for the UK and West Germany provide evidence that reservation wages are much less cyclical than predicted even conditional on the observed level of wage cyclicality. We present evidence that elements of perceived “fairness” or “reference points” in reservation wages may address this model failure.

Keywords: Reservation wages; wage cyclicality; reference points. (search for similar items in EconPapers)
JEL-codes: E24 J31 J64 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2014-12
New Economics Papers: this item is included in nep-lab, nep-ltv and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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http://eprints.lse.ac.uk/60613/ Open access version. (application/pdf)

Related works:
Working Paper: Reservation wages and the wage flexibility puzzle (2016)
Working Paper: Reservation wages and the wage flexibility puzzle (2016)
Working Paper: Reservation wages and the wage flexibility puzzle (2016)
Working Paper: Reservation Wages and the Wage Flexibility Puzzle (2016)
Working Paper: Reservation Wages and the Wage Flexibility Puzzle (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:60613

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