Sticky wages are part of the macro labor market story, but not at the center

I can recommend to you this new survey by Lars Ljungqvist and Thomas J. Sargent, just published in the American Economic Review.  The serious work on unemployment these days is using models of matching markets, and varying returns to finding matches during tough times, including recessions.  That is how to think about the job creation process for unemployed workers, who do not currently have a nominal wage to even be sticky.  Here is their abstract:

To generate big responses of unemployment to productivity changes, researchers have reconfigured matching models in various ways: by elevating the utility of leisure, by making wages sticky, by assuming alternating-offer wage bargaining, by introducing costly acquisition of credit, by assuming fixed matching costs, or by positing government-mandated unemployment compensation and layoff costs. All of these redesigned matching models increase responses of unemployment to movements in productivity by diminishing the fundamental surplus fraction, an upper bound on the fraction of a job’s output that the invisible hand can allocate to vacancy creation. Business cycles and welfare state dynamics of an entire class of reconfigured matching models all operate through this common channel.

As you will see in the paper, sticky or constant wages still can play a significant role in these accounts, but they are one part of a broader story. This is useful from the concluding remarks:

The fundamental surplus fraction is the single intermediate channel through which economic forces generating a high elasticity of market tightness with respect to productivity must operate. Differences in the fundamental surplus explain why unemployment responds sensitively to movements in productivity in some matching models but not in others. The role of the fundamental surplus in generating that response sensitivity transcends diverse matching models having very different outcomes along other dimensions that include the elasticity of wages with respect to productivity, and whether outside values affect bargaining outcomes.
For any model with a matching function, to arrive at the fundamental surplus, take the output of a job, then deduct the sum of the value of leisure, the annuitized values of layoff costs and training costs and a worker’s ability to exploit a firm’s cost of delay under alternating-offer wage bargaining, and any other items that must be set aside. The fundamental surplus is an upper bound on what the invisible hand could allocate to vacancy creation. If that fundamental surplus constitutes a small fraction of a job’s output, it means that a given change in productivity translates into a much larger percentage change in the fundamental surplus. Because such large movements in the amount of resources that could potentially be used for vacancy creation cannot be offset by the invisible hand, significant variations in market tightness ensue, causing large movements in unemployment.

One very simple way to put the point is that unemployment is not always such an easy problem to fix and labor markets are not always so easy to steer. This is a far cry from the simple Phillips curve talk I see so often in the financial press.

Here are ungated copies.


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