Does Wage Persistence Matter for Employment Fluctuations ?

Recent work by Robert Shimer (2005) has stressed the difficulties of the standard Dale T. Mortensen and Christopher A. Pissarides (1994) model in explaining the cyclical movement of unemployment. As potential mechanism behind observed employment dynamics, several papers (e.g., Shimer 2004, Robert Hall 2005, and Hall and Paul Milgrom 2008) have suggested rigidities in the wage setting process that prevent wages from declining during an economic downturn. However, the ability of wage rigidities to explain aggregate employment fluctuations crucially depends on their sources. For example, on the one hand Hall (2005) finds that contractually rigid wages can generate movements in employment of the right order of magnitude. On the other hand, Leena Rudanko (2009) suggests that employment changes implied by implicit insurance contracts cannot reproduce observed cyclical fluctuations.