Stubborn Beliefs in Search Equilibrium

Guido Menzio

No 29937, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: I study a search equilibrium model of the labor market in which workers have stubborn beliefs about their labor market prospects, i.e. beliefs about their probability of finding a job and the wage they will earn that do not respond to aggregate fluctuations in fundamentals. I show that, when workers have stubborn beliefs, the response of the wage bargained by a firm and a worker to aggregate shocks is dampened. As a result, the response of labor market tightness, job-finding probability, unemployment and vacancies to aggregate fluctuations is amplified. I show that stubborn beliefs generate cyclical inefficiencies in the labor market that can be corrected with countercyclical employment subsidies. I find that the response of the labor market to negative shocks is the same even if only a small fraction of workers has stubborn beliefs. In contrast, if the fraction of workers with stubborn beliefs is small, the response of the labor market to positive shocks is approximately the same as under rational expectations.

JEL-codes: E03 E32 (search for similar items in EconPapers)
Date: 2022-04
New Economics Papers: this item is included in nep-dge, nep-lab and nep-mac
Note: EFG
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Citations: View citations in EconPapers (7)

Published as Stubborn Beliefs in Search Equilibrium , Guido Menzio. in NBER Macroeconomics Annual 2022, volume 37 , Eichenbaum, Hurst, and Ramey. 2023

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