25 Jahre IWH

Veranstaltung
21
Nov 2016

14:15 - 15:45

Uncertainty, Wages, and the Business Cycle

We show that occasional deviations from effcient wage-setting generate strong and statedependent amplication of exogenous uncertainty shocks and contribute to explain the observed countercyclicality of empirical measures of aggregate uncertainty.

Speaker
Professor Federico Ravenna , Institute of Applied Economics, HEC Montréal
Location
IWH-Konferenzsaal
Professor Federico Ravenna

Über den Autor

Professor Federico Ravenna

Federico Ravenna is Head of Research at Danmarks Nationalbank and holds the Chair in Monetary Policy and Financial Markets at the the Department of Applied Economics at HEC Montréal, which he joined in August 2009. He was previously a tenured professor of Economics at the University of California – Santa Cruz, which he joined in 2001 after receiving his doctorate from New York University.

We show that occasional deviations from effcient wage-setting generate strong and statedependent amplication of exogenous uncertainty shocks and contribute to explain the observed countercyclicality of empirical measures of aggregate uncertainty. Central to our analysis is the existence of matching frictions in the labor market and an occasionally binding constraint on downward wage adjustment. The wage constraint enhances the concavity of the firms’ hiring rule, generating an endogenous profit-risk premium. In turn, uncertainty shocks increase the profit-risk premium when the economy operates close to the wage constraint. This implies that higher uncertainty can severely deepen a recession although its impact is weaker on average. Additionally, the variance of the unforecastable component of future economic outcomes always increases at times of low economic activity. Thus, measured uncertainty rises in a recession even in the absence of uncertainty shocks. We obtain our results using a fourth-order Taylor expansion to the model policy functions, approximating the non-convexity in the wage decision rule with a novel implementation of penalty function methods.

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