Wage rigidity and workers’ flows during recessions

New SSE Riga/BICEPS research paper by Anete Pajuste (SSE Riga) and Hernan Ruffo (UTDT).

Abstract. Wage rigidity generates higher unemployment volatility in matching models. By comparing the wage dynamics and workers’ mobility during the period 2004-11 in Spain and Latvia we provide empirical evidence to this effect. We find that wages in Spain were rigid even during periods of rising and high unemployment. In contrast, Latvian wages were reduced by about 10 percent and wage cuts affected 60 percent of jobs. At the same time, the elasticity of finding and separation rates to productivity shocks was four times higher in Spain than in Latvia, and that these responses were more persistent in Spain. We use finding and separation conditions from a matching model to show that these empirical results are in line with what a model would predict. We also emphasize that separations are very responsive to shocks, more so in a rigid-wage economy, a fact that has not been highlighted in theoretical literature.