Labor-market Frictions, Incomplete Insurance and Severance Payments
37 Pages Posted: 7 Dec 2014 Last revised: 10 Feb 2019
Date Written: October 1, 2018
We analyze the effects of government-mandated severance payments in a rich life-cycle model with search-matching frictions in the labor market, risk-averse agents and imperfect insurance against idiosyncratic shocks. Our model emphasizes a tension between worker-firm wage bargains and consumption smoothing: entry wages respond to expected future severance payments by tilting downwards, which runs counter to having a smooth consumption path. Quantitatively, we find that these wage-shifting effects are sizable enough for severance payments to produce large welfare losses. Our assessment contrasts sharply with previous studies that restricted the extent of worker-firm bargaining to analyze the welfare implications of severance payments.
Keywords: Severance Payments, Labor-market Frictions, Precautionary Savings, Welfare
JEL Classification: E21, I38, J63, J65
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