A fair wage model of unemployment with inertia in fairness perceptions

Theories of psychology and empirical evidence suggest that the reference transactions against which workers judge fairness exhibit inertia. This paper shows that a fair-wage model with inertia in fairness perceptions provides a plausible explanation for the observed negative correlation between changes in productivity growth and equilibrium unemployment over the medium run, a stylized fact that remains elusive to most other classes of models. It also shows that skill-biased productivity shocks and shocks to workers' taste for equal pay have permanent effects on unemployment and the skill premium. Thus, skill-biased shocks to productivity increase unemployment among the low-skilled while, if high-skilled workers are less inequity-averse, they reduce unemployment among the high-skilled. Copyright 2014 Oxford University Press 2012 All rights reserved, Oxford University Press.