Events at CERGE-EI

Marta Garcia Rodriguez, M.A.

Universitat Autònoma de Barcelona, Spain

Abstract: The standard search and matching model does not reproduce some key aspects of the US labor market, in particular, the high volatility in vacancies and unemployment and the null contemporaneous correlation between the vacancy-unemployment ratio and labor productivity from 1990-2020. In addition, I document that survey wage expectations and rational wage expectations covary differently with labor productivity. I formally reject the hypothesis that this is compatible with rational expectations. This paper develops a search and matching model applied to the business cycle with internally rational agents. Even though agents hold subjective expectations about wages, they behave rationally given these expectations. The inclusion of learning significantly improves the model’s fit with US data compared to its rational expectations counterpart. During expansionary periods, agents underestimate future wages amplifying the effect of productivity shocks on the labor market. In light of this model, certain countercyclical unemployment insurance policy rules may lead to instability in the belief system, making them undesirable.

JEL Classification: E24, E32, E83
Keywords: Internal Rationality, Wage Expectations, Labor Market, Subjective Expectations, Belief Shock

Full Text: The Role of Wage Expectations in the Labor Market