Uncertainty, Wages and the Business Cycle

Matteo Cacciatore and Federico Ravenna

The Economic Journal, 2021, vol. 131, issue 639, 2797-2823

Abstract: We show that limited wage flexibility in economic downturns generates strong and state-dependent amplification of uncertainty shocks. It also explains the cyclical behaviour of empirical measures of uncertainty. In the presence of matching frictions, an occasionally binding constraint on downward wage adjustment enhances the concavity of firms’ hiring rule, resulting in an endogenous profit risk-premium. In turn, higher uncertainty increases the profit risk-premium when the economy operates close to the wage constraint, deepening a recession. Non-linear local projections and vector autoregression estimates support the model predictions. In addition, we show that measured uncertainty rises in a recession even without uncertainty shocks.

Date: 2021
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Citations: View citations in EconPapers (12)

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Working Paper: Uncertainty, Wages, and the Business Cycle (2020)
Working Paper: Uncertainty, Wages, and the Business Cycle (2020)
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