Firm Wages in a Frictional Labor Market

Leena Rudanko
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Leena Rudanko: Federal Reserve Bank of Philadelphia

No 1154, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies a labor market with search frictions and directed search, where firms employ multiple workers and follow a firm-wage policy: a firm pays all its (equally productive) workers the same. The policy introduces a tension into the static firm problem, between setting a high wage to attract more new workers versus a low one to economize on labor costs on existing ones. The policy also introduces a time-inconsistency into the dynamic firm problem that affects equilibrium allocations. A firm with commitment plans on higher wages in the future than in the short run, where the firm takes advantage of its existing workers with a low wage. I study labor market outcomes when firms cannot commit to future wages, and show that one can, despite the time-inconsistency, analyze Markov-perfect equilibria using a standard Euler equation approach. The model generates endogenous real wage rigidity as firms raising wages to increase hiring in an expansion must raise them for all workers instead of only new hires. The commitment problem also gives a motive for firms to adjust wages only infrequently, as observed. An equilibrium where firms adjust wages infrequently can be better for welfare, especially that of workers.

Date: 2018
New Economics Papers: this item is included in nep-dge
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Working Paper: Firm Wages in a Frictional Labor Market (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:1154

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