MACRODYNAMIC EFFECTS OF EFFICIENCY WAGES AND WAGE DISCRIMINATION POLICIES MODELED WITH HABIT FORMATION IN CONSUMPTION

Abstract

This dissertation consists of two independent chapters, and an introductory first chapter with background and summary. While they have some theoretical and analytical tools in common, the models are independent of each other and each chapter can be read and understood by itself and makes its own contribution to the subject studied. Chapter one reviews a segment of the literature on real business cycle research, focusing first on the modeling of efficiency wages to create equilibrium unemployment, then on the use habit formation in consumption to capture some dynamic features of macroeconomic variables. My innovation in the chapters that follow is adding habit formation in consumption to a shirking efficiency wage model, and applying DSGE techniques to create a laboratory where questions of the dynamic effects of altering model parameters can be addressed by Impulse response and simulations that include stochastic shocks to the economy. This chapter includes information about the differences between two models that are studied in chapters two and three, which are theoretical differences in how the habit formation is modeled, and applied to different questions. Chapter two constructs an equilibrium model that combines external habit formation in consumption and efficiency wages arising from imperfectly observable effort to evaluate wage, employment, and output dynamics under fiscal and technology shocks. At certain levels of insurance and habit formation employment output correlations and output volatilities match US data better than a model without habit formation. However, increased employment volatility and counter- factual negative wage-employment correlations emerge. I use impulse response functions to explain the mechanisms that give rise to the observed changes in second moments. Chapter three builds on the result by using a similar analytical framework to pose a policy question. Comparing results from two models, one where a wage gap arises from heterogeneous worker history and another where an equal wage is enforced, impulse response experiments compare the respective welfare costs of a negative shock to technology in either case. The welfare cost of a recession caused by a negative technology shock of one standard deviation in this simulation, when wage equality is enforced, as compared to when employers are allowed to negotiate wages with individuals based on past employment status, is about 1.0% per year for 45 years, if expressed as a compensating variation in consumption, due to a deeper and more persistent drop in employment before a return to steady state growth.