Working Paper

The economics of labor adjustment : mind the gap

Abstract: We study the inferences about labor adjustment costs obtained by the \"gap methodology\" of Caballero and Engel [1993] and Caballero, Engel and Haltiwanger [1997]. In that approach, the policy function of a manufacturing plant is assumed to depend on the gap between a target and the current level of employment. Using time series observations, these studies reject the quadratic cost of adjustment model and find that aggregate employment dynamics depend on the cross sectional distribution of employment gaps. We argue that these conclusions may not be justified. Instead these findings may reflect difficulties measuring the gap. Thus it appears that the gap methodology as currently employed, may be unable to: (i) identify the costs of labor adjustment and (ii) assess the aggregate implications of labor adjustment costs.

Keywords: Employment (Economic theory);

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2001

Number: RWP 01-06