Business Cycles, Wage Setting, and Asymmetric Information

This paper explores wage-setting in the presence of asymmetric information. Firms know their own productivity, while workers only know the distribution of productivity in the economy. Although there is unemployment in equilibrium, the labor market is competitive in the sense of Moen (1997): firms commit to wage contracts in an effort to attract job applicants. The paper shows that an increase in the average level of productivity or an increase in the variance of productivity raises the equilibrium wage, while an increae in average productivity or a reduction in the variance reduces unemployment. It follows that if recessions are chararacterized by low average productivity and a high variance, the model can explain large (un)employment fluctuations associated with small changes in wages