Comment

Guido Menzio’s paper, “Stubborn Beliefs in Search Equilibrium,” provides a new and provocative approach to a set of long-standing questions in the macro labor literature. What is the source of downward wage rigidity? And how can one of the workhorse models in this literature— the random-search model pioneered by Diamond, Mortensen, and Pissarides (DMP)—generate realistic cyclical fluctuations in vacancies and unemployment? Menzio proposes a novel mechanism for wage rigidity, which relies on the presence of nonrational workers in an otherwise standard DMP model. These “stubborn” workers do not have rational expectations but instead have biased beliefs about the aggregate state of the economy. More specifically, they believe that aggregate productivity is constant and equal to its unconditional mean of the productivity distribution, failing to recognize booms or recessions. In a downturn, workers who contemplate forming a match with a firm therefore have beliefs about their outside option—the value of search—that are too optimistic, which affects the wages they bargain. In fact, wages are entirely pinned down by workers’ beliefs, because firms have no choice but to accommodate these biased beliefs as they cannot be changed. Wages are therefore too high compared with what a recession would call for; that is, they are downward sticky/rigid. As a result, firms’ incentives to post vacancies strongly diminish. In the presence of stubborn workers, aggregate productivity