Firm Wages in a Frictional Labor Market

40 Pages Posted: 24 Jan 2019 Last revised: 21 Feb 2019

See all articles by Leena Rudanko

Leena Rudanko

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Date Written: 2019-01-22


This paper studies a labor market with directed search, where multi-worker firms follow a firm wage policy: They pay equally productive workers the same. The policy reduces wages, due to the influence of firms’ existing workers on their wage setting problem, increasing the profitability of hiring. It also introduces a time-inconsistency into the dynamic firm problem, because firms face a less elastic labor supply in the short run. To consider outcomes when firms reoptimize each period, I study Markov perfect equilibria, proposing a tractable solution approach based on standard Euler equations. In two applications, I first show that firm wages dampen wage variation over the business cycle, amplifying that in unemployment, with quantitatively significant effects. Second, I show that firm wage firms may find it profitable to fix wages for a period of time, and that an equilibrium with fixed wages can be good for worker welfare, despite added volatility in the labor market.

Keywords: Labor Market Search, Business Cycles, Wage Rigidity, Competitive Search, Limited Commitment

JEL Classification: E24, E32, J41, J64

Suggested Citation

Rudanko, Leena, Firm Wages in a Frictional Labor Market (2019-01-22). FRB of Philadelphia Working Paper No. 19-5, Available at SSRN: or

Leena Rudanko (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
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