Real wage rigidity and the unemployment volatility puzzle in small open economies

Standard search models of the labour market feature a volatility puzzle: labour market variables move too little in response to productivity shocks. I investigate if real wage rigidity is sufficient to solve this in an open economy. Starting from a closed economy benchmark in which wage rigidity mak...

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Bibliographic Details
Published in:Oxford economic papers 2016-01, Vol.68 (1), p.131-151
Main Author: Krogh, Tord S.
Format: Article
Language:English
Subjects:
Economic models
Labor market
Labour market
Productivity
Real wages
Studies
Terms of trade
Unemployment
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Summary:Standard search models of the labour market feature a volatility puzzle: labour market variables move too little in response to productivity shocks. I investigate if real wage rigidity is sufficient to solve this in an open economy. Starting from a closed economy benchmark in which wage rigidity makes labour market variables sufficiently volatile, I find that the puzzle reopens in the open economy, despite a rigid real wage. This is because terms of trade movements move the wedge between the consumer and producer real wage in such a way that labour market variables respond less to productivity shocks. A quantitative exercise shows that the effect of this mechanism can be sizeable.
ISSN:0030-7653
1464-3812
DOI:10.1093/oep/gpv059