Finance and Economics Discussion Series (FEDS)
The Cyclical Behavior of Unemployment and Wages under Information Frictions
I propose a new mechanism for sluggish wages based on workers' noisy information about the state of the economy. Wages do not respond immediately to a positive aggregate shock because workers do not (yet) have enough information to demand higher wages. This increases firms' incentives to post more vacancies, which makes unemployment volatile and sensitive to aggregate shocks. The model is robust to two major criticisms of existing theories of sluggish wages and volatile unemployment: flexibility of wages for new hires and pro-cyclicality of the opportunity cost of employment. Calibrated to U.S. data, the model explains 70% of unemployment volatility.
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Keywords: Information Frictions, Unemployment, Wages and compensation
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