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Prof. Ran Spiegler

University College London, United Kingdom and Tel Aviv University, Israel

Authors: Kfir Eliaz and Ran Spiegler

Abstract: We incorporate reference-dependent preferences into a search-and-matching model of the labor market, in which firms have all the bargaining power and productivity follows an AR(1) process. Motivated by Akerlof (1982) and Bewley (1999), we assume that workers prefer to exert unobserved, “intrinsically motivated” effort as long as their wage does not fall below a "reference wage", which (broadly following Köszegi and Rabin (2006)) is equal to the worker’s lagged-expected wage earnings. We formulate the model game-theoretically and show that under certain conditions it has a unique subgame perfect equilibrium that exhibits the following properties: existing workers experience downward wage rigidity as well as destruction of output following negative shocks due to layoffs or loss of morale; newly hired workers earn relatively flexible wages, but not as much as in the benchmark without reference dependence; market tightness is more volatile than under this benchmark. We relate these findings to the debate over the “Shimer puzzle” (Shimer (2005)).

Full Text: “Reference Dependence and Labor Market Fluctuations”