Pecuniary Externalities in Economies with Downward Wage Rigidity
Martin Wolf ()
Vienna Economics Papers from University of Vienna, Department of Economics
We describe a pecuniary externality in economies with downward nominal wage rigidity that leads arms to hire too many workers in expansions, which leads to too much unemployment in recessions. The externality arises because of competitive behavior in the labor market. When ?rms hire more workers, they push up market wages for all ?rms. Firms internalize that with higher wages, it is more likely that they will be constrained by downward nominal wage rigidity in the future themselves; however, they fail to internalize the negative e?ects over other arms. In the calibrated model, when compared to a benevolent planner who chooses labor allocations on behalf of arms, the externality raises the welfare cost of downward nominal wage rigidity by a factor of 10, as it makes the economy signifcantly more exposed to unemployment crises.
JEL-codes: E24 E32 F41 (search for similar items in EconPapers)
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