Incentives in Competitive Search Equilibrium

Abstract

This paper proposes a labor market model with job search frictions where workers have private information on match quality and effort. Firms use wage contracts to motivate workers. In addition, wages are also used to attract employees. We define and characterize competitive search equilibrium in this context, and show that it satisfies a simple modified Hosios rule. The model is used to address the "Shimer puzzle" related to the low volatility of the unemployment rate relative to the volatility of output observed in the data. We find that private information may increase the responsiveness of the unemployment rate to changes in productivity and in particular to changes in the information structure.

Keywords: Private information, incentives, search, unemployment, wage rigidity

JEL Classification: E30, J30, J60