Uncertainty, Wages, and the Business Cycle

Federico Ravenna and Matteo Cacciatore

No 14715, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We show that occasional deviations from efficient wage setting generate strong and state-dependent amplification of uncertainty shocks and can explain the cyclical behavior of empirical measures of uncertainty. Central to our analysis is the existence of matching frictions in the labor market and an occasionally binding constraint on downward wage adjustment. The wage constraint enhances the concavity of firms' hiring rule, generating an endogenous profit-risk premium. In turn, uncertainty shocks increase the profit-risk premium when the economy operates close to the wage constraint. This implies that higher uncertainty can severely deepen a recession, although its impact is weaker on average. Additionally, the variance of the unforecastable component of future economic outcomes always increases at times of low economic activity. Thus, measured uncertainty rises in a recession even in the absence of uncertainty shocks.

Keywords: Uncertainty; Business cycle; Unemployment; Occasionally binding constraints (search for similar items in EconPapers)
JEL-codes: E2 E32 E6 (search for similar items in EconPapers)
Date: 2020-05
New Economics Papers: this item is included in nep-dge, nep-lma and nep-mac
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Citations: View citations in EconPapers (9)

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Related works:
Journal Article: Uncertainty, Wages and the Business Cycle (2021)
Working Paper: Uncertainty, Wages, and the Business Cycle (2020)
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