Economic Inquiry

Volume53, Issue1，January 2015，Pages419-430

A Competitive Model of Worker Replacement and Wage Rigidity

Andy Snell  Jonathan P. Thomas Zhewei Wang

We adapt the models of Menzio and Moen (2010) and Snell and Thomas (2010) to consider a labor market in which firms can commit to wage contracts but cannot commit not to replace incumbent workers. Workers are risk averse, so that there exists an incentive for firms to smooth wages. Real wages respond in a highly nonlinear manner to shocks, exhibiting downward rigidity, and magnifying the response of unemployment to negative shocks. We also consider layoffs and show that for a range of shocks labor hoarding occurs while wages are cut. We argue these features are consistent with recent evidence . (JEL E32, J41)