Journal Article

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

Tord S. Krogh

in Oxford Economic Papers

Volume 68, issue 1, pages 131-151
Published in print January 2016 | ISSN: 0030-7653
Published online August 2015 | e-ISSN: 1464-3812 | DOI: https://dx.doi.org/10.1093/oep/gpv059
Real wage rigidity and the unemployment volatility puzzle in small open economies

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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.

Keywords: E24; E32; F41

Journal Article.  7705 words.  Illustrated.

Subjects: Macroeconomics: Consumption, Saving, Production, Employment, and Investment ; Prices, Business Fluctuations, and Cycles ; Macroeconomic Aspects of International Trade and Finance

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