Education and the Margins of Cyclical Adjustment in the Labor Market

Overview

Research question. This paper asks how the cyclical sensitivity of wages varies with workers’ educational attainment, what mechanisms drive the differences, and what the welfare consequences are of ignoring this heterogeneity. The starting point is a well-known asymmetry: less-educated workers have much higher and more volatile job separation rates, yet the standard macroeconomic literature has treated wages as roughly acyclical for a representative worker. Doniger asks whether this employment-centric picture is incomplete—and finds that it is, in a direction opposite to what the employment pattern would suggest.

Data and methodology. The paper uses two primary data sources: the National Longitudinal Survey of Youth 1979 (NLSY), which provides detailed job histories enabling identification of current and completed employer tenure, and the Current Population Survey (CPS) from 1995 to 2020, used both for employment flow statistics and, via biennial Job Tenure Supplements, for replication of the main wage findings. The sample is restricted throughout to males with 0–30 years of potential experience, following the conventions of the user-cost-of-labor (UCL) literature (Kudlyak, 2014; Basu and House, 2016). Workers are grouped into three educational categories: less than high school, high school or some college, and bachelor’s degree or more.

A key methodological contribution is a new, more parsimonious estimator for the cyclical sensitivity of the UCL. Rather than the multi-step indicator-variable approach of Kudlyak (2014), the paper recovers the UCL sensitivity from interaction terms between a flexible function of tenure and the cyclical position at the time of hiring, estimated within an augmented Mincer regression. This estimator admits higher-frequency identification, enables transparent inference via the delta method, and facilitates nonparametric impulse response estimation via the Jorda (2005) local projection method. Cyclical position is measured primarily as the deviation of the unemployment rate from an HP-filtered trend (lambda = 100,000), with robustness checks using the Hamilton (2018) filter and GDP-based detrending.

Main findings — employment. Monthly separation rates from the CPS (1995–2020) show that workers with less than a high school degree separate at a rate of 9.4 percent per month, more than twice the 3.4 percent rate for workers with a bachelor’s degree or more, regardless of cyclical position. The volatility of the separation rate (measured by the time-series standard deviation) is also larger for the least educated (1.7) than for the most educated (0.6). All sub-components of separation-to unemployment, to inactivity, and job-to-job transitions-exhibit the same ordering. In response to a 100 basis point monetary policy contraction (Romer and Romer, 2004 shocks), employment of workers with less than a high school education falls significantly, while employment of college graduates or more is statistically unaffected.

Main findings — wages. Using the NLSY, the cyclical sensitivity of the UCL to a 1 percentage point deviation of the unemployment rate from trend is estimated at approximately −15.5 percent for workers with a bachelor’s degree or more, −4.9 percent for high school or some college workers, and −1.4 percent (statistically indistinguishable from zero) for workers without a high school degree. In contrast, average hourly earnings (AHE) show much smaller and more compressed differences across education groups (−1.4, −1.1, and −1.0 percent respectively). The pattern of increasing procyclicality with education holds for new hires’ wages (NHW) as well but is considerably less stark than for the UCL. Replication in the CPS confirms the ordering: UCL sensitivities are −7.0 percent for college graduates, −2.9 percent for high school or some college, and effectively zero for those without a high school degree.

Mechanism. Counterfactual decompositions show that differences in the cyclical sensitivity of the wage-tenure profile—not just differences in job duration (separation rates)-account for the vast majority of the divergence across education groups. When separation rates are held constant across groups, the UCL sensitivity of the college-educated falls from -15.5 to −13.0 percent; when wage-tenure profile sensitivities are held constant, it falls to −6.3 percent, and the ordering across groups largely disappears. This finding is consistent with implicit contracting theory (Thomas and Worrall, 1988): longer expected employment durations for the more educated make it optimal to defer a greater share of the wage response to shocks over time, rendering near-term rigidities functionally less binding and producing more persistent effects of hiring-period conditions on subsequent wages.

Robustness. After controlling for cyclical sorting in match quality using the Hagedorn and Manovskii (2013) proxies (cumulated market tightness during tenure and leading up to the present job), the UCL sensitivity for college graduates falls modestly to −12.4 percent, confirming that match-quality composition effects account for only a minority of the documented pattern. The monetary policy shock analysis (Romer-Romer shocks identified from Greenbook forecast errors) yields a 35 percent decrease in the UCL for the most educated at the two-year horizon following a 100 basis point contraction, with no discernible effect for the least educated.

Welfare consequences. Using a stylized New Keynesian model extended to two labor varieties with heterogeneous wage flexibility, the paper shows that ignoring the documented heterogeneity leads to underestimating the welfare costs of business cycle fluctuations by more than 15 percent under the baseline calibration (unit Frisch elasticity and unit elasticity of intertemporal substitution). Conditional on this model, the welfare loss due to fluctuations for the least educated is more than 15 times larger than for the most educated. The paper explicitly notes this is a conservative lower bound, because the model assumes pooled household consumption, and admitting idiosyncratic consumption risk would disproportionately burden less-educated workers who bear adjustment on the extensive (employment) rather than intensive (wage) margin.

Q&A

Q1. What is the user cost of labor (UCL), and why does the paper use it rather than average hourly earnings or new hires’ wages?

The UCL, formalized by Kudlyak (2014), is the present discounted value of wage payments an employer expects to make to a worker over the duration of the employment relationship, net of the continuation value of retaining that worker. It equals the new hire’s wage plus the expected wage wedge—the discounted stream of future wage differences between workers hired in the current period versus workers hired one period later. Unlike average hourly earnings or new hires’ wages, the UCL captures the persistent effects of macroeconomic conditions at the time of hiring on all future remitted wages, making it the appropriate allocative wage concept from a macroeconomic standpoint. The paper documents that AHE understates the cyclicality of wages for all groups but especially for the most educated, because AHE omits the highly cyclically sensitive expected wage wedge that characterizes college-educated employment relationships.

Q2. How does the paper’s new estimator for the cyclical sensitivity of the UCL differ from the existing method, and what does this enable?

The existing Kudlyak (2014)/Basu and House (2016) method recovers the UCL by estimating a very large set of date-of-hire x current-date indicator interactions, constructing a time series of the UCL, and then analyzing that series—a multi-step procedure that loses covariances across steps and makes cross-sectional disaggregation or high-frequency identification impractical. The new method instead estimates the UCL sensitivity directly from coefficients on the interaction between a flexible tenure function and the cyclical position at hiring, estimated within a single augmented Mincer regression. The UCL semi-elasticity is recovered analytically from these coefficients via a formula that sums discounted weighted differences in the tenure-interaction coefficients across the tenure horizon. This single-step approach allows transparent inference via the delta method, enables fully interacted specifications for heterogeneous subgroups, permits the hiring-date frequency (e.g., weekly in NLSY) to differ from the wage observation frequency (annual or biannual), and permits estimation from repeated cross-sections—all of which were infeasible in the prior approach.

Q3. What are the quantitative magnitudes of the education gradient in UCL cyclicality, and how do they compare across wage measures?

Using the NLSY with unemployment deviations from HP-filtered trend as the cyclical indicator: the UCL sensitivity is −15.5 percent (se 3.86) for workers with a bachelor’s degree or more, −4.9 percent (se 1.52) for high school or some college, and −1.4 percent (se 2.48, statistically insignificant) for those without a high school degree. By contrast, new hires’ wages show sensitivities of −3.4, −1.8, and −1.2 percent respectively, and average hourly earnings show −1.4, −1.1, and −1.0 percent. The gradient is largest and most statistically significant for the UCL, indicating that the bulk of the education gap in cyclical wage sensitivity operates through the persistent effect of hiring-period conditions on subsequent wages rather than through the contemporaneous wage alone.

Q4. What mechanism accounts for the UCL gradient — differential job durations or differential sensitivity of the wage-tenure profile?

The paper decomposes the UCL into the new hire’s wage and the expected wage wedge, and performs counterfactual exercises holding either separation rates or wage-tenure profile sensitivities constant across education groups (Table 3). Holding separation rates constant while allowing wage-tenure profiles to differ reduces the college-educated UCL sensitivity only modestly, from -15.5 to −13.0 percent; holding wage-tenure profile sensitivities constant while allowing separation rates to differ reduces the college-educated sensitivity to −6.3 percent and compresses the education gradient substantially. Thus, differential sensitivity of the wage-tenure profile—the degree to which wages continue to respond to hiring-period conditions over the course of the job-is the primary driver of the UCL gradient, with differential separation rates playing a secondary but non-trivial role. This finding confirms the prediction of Thomas and Worrall (1988) that lower separation rates support greater use of deferred payment and intertemporal risk sharing in optimal wage contracts.

Q5. How does the paper rule out cyclical sorting in match quality as the explanation for the UCL gradient?

Workers hired during recessions may be of systematically lower match quality, producing persistently lower wages not because wages are more cyclically sensitive for the same quality match but because recession hires are worse matches. Using the Hagedorn and Manovskii (2013) proxies for match quality - cumulated market tightness during the worker’s tenure on the present job (mjob) and on all prior jobs leading to it (mctj) - the paper augments the wage regression with full interactions between these proxies and the tenure-cyclicality terms. After controlling for match quality, the UCL sensitivity for college graduates falls from -15.5 to −12.4 percent (se 5.56); the point estimate remains large, statistically significant, and well above the estimates for lower-education groups. Figure 4 shows that match-quality adjustment primarily affects the first two years of the wage-tenure profile, after which the bias from cyclical sorting fades, confirming that scarring in remuneration for college graduates hired in recessions persists beyond what sorting can explain.

Q6. What do monetary policy shocks reveal about the education gradient in wage sensitivity?

Monetary policy shocks (identified from Greenbook forecast errors as in Romer and Romer, 2004) subject all labor markets to the same aggregate demand shock simultaneously, providing a cleaner test of differential responsiveness than cyclical regressions that may conflate demand composition and supply factors. Using Jorda (2005) local projections, a 100 basis point monetary policy contraction is associated with a 35 percent decrease in the UCL for workers with a bachelor’s degree or more at the two-year horizon, with statistically insignificant effects on the UCL of workers without a high school degree. The employment results are symmetric: less-educated workers’ employment falls significantly after a monetary contraction, while college-educated workers’ employment is unaffected. This cross-validation using monetary policy shocks supports the main thesis that more-educated workers absorb aggregate demand variation through the wage margin, while less-educated workers absorb it through the employment margin.

Q7. How does acyclical wages for the least educated affect interpretation of the existing macro literature on wage rigidity?

The aggregate finding of Kudlyak (2014) and Basu and House (2016)-that the UCL is more procyclical than new hires’ wages or average hourly earnings, casting doubt on wage rigidity as an amplification mechanism—holds only for educated workers. The paper finds that the UCL for workers without a high school degree is statistically acyclical by all three wage measures. This result restores a potential role for nominal wage rigidity in generating amplification and persistence of shocks for less-educated labor markets, including in the Diamond-Mortensen-Pisarides class of search models criticized by Kudlyak (2014) and in New Keynesian models criticized by Basu and House (2016). The paper therefore reconciles the literature on wage rigidity with the empirical finding of cyclical employment volatility concentrated among the less educated.

Q8. What is the welfare calculation, and what are its key results and limitations?

The welfare exercise uses a parsimonious New Keynesian model with two labor varieties (capturing more- and less-educated workers) and price and wage rigidities. The model is extended to admit heterogeneous wage flexibility, and the welfare costs of fluctuations are evaluated following the second-order approximation method of Gali et al. (2007). Under the baseline calibration (unit Frisch elasticity, unit elasticity of intertemporal substitution), the heterogeneous-worker economy incurs welfare costs of fluctuations that exceed those of the output-gap-equivalent representative agent economy by more than 15 percent. The welfare loss of the least-educated workers is more than 15 times that of the most educated. The paper explicitly characterizes this as a conservative lower bound: the model assumes pooled household consumption (within varieties), which implies equal consumption sensitivity across education groups, whereas in reality less-educated workers face income loss on the extensive margin without the wage smoothing available to the more educated. Relaxing this assumption, as in Krusell et al. (2009), could yield welfare losses an order of magnitude larger.

Q9. What does the CPS replication add, and what are its limitations relative to the NLSY baseline?

The CPS replication (Table 7) confirms the main ordering: UCL sensitivities are −7.0, −2.9, and approximately 0 percent for college graduates, high school or some college, and less than high school respectively. This rules out the concern that the NLSY findings are artifacts of the single aging cohort that characterizes the NLSY 1979. However, the CPS must be treated as a repeated cross-section because the tenure data are only available biennially and individual-level panel linkage across tenure supplement waves is infeasible. As a result, the CPS estimates cannot include individual fixed effects and must rely more heavily on observable controls (industry, occupation) to absorb cyclical variation in workforce composition. The CPS also precludes the match-quality controls of Hagedorn and Manovskii (2013). Despite these limitations, the main qualitative and directional findings replicate.

Q10. What policy implications does the paper draw for monetary policy?

The paper argues that because less-educated workers bear adjustment to aggregate demand shocks disproportionately through the employment margin while their wages are acyclical, welfare assessments that focus on the aggregate output gap underweight the costs borne by less-educated workers. The paper suggests that re-optimizing the monetary policy rule to account for documented heterogeneity would entail placing greater weight on the unemployment rate of the least-educated when measuring the output gap. More broadly, the K-shaped nature of labor market adjustment across education groups — wage scarring for the educated versus employment volatility for the less educated - implies that policies targeting either margin in isolation will miss welfare costs concentrated in the other group.

Key Concepts

User Cost of Labor (UCL). The allocative wage from the employer’s perspective, defined as the present discounted value of expected future wage payments to a worker hired at date t, net of the continuation value of retaining that worker in the next period. Formally, UCL_t = w_{t,t} + E_t[sum beta^j(1-s)^j (w_{t+j,t} - w_{t+j,t+1})], decomposing into the new hire’s wage and the expected wage wedge. In this paper’s usage, the UCL is the appropriate measure of the cyclical impact of shocks on labor costs because it captures persistent effects of hiring-period conditions on the entire subsequent wage sequence, not just the contemporaneous wage.

Expected Wage Wedge (EWW). The component of the UCL beyond the new hire’s wage: the discounted stream of differences between wages a worker hired at date t will receive in future periods and the wages a worker hired one period later would receive in those same future periods. The EWW is non-zero whenever wages are history-dependent - i.e., whenever current macroeconomic conditions at the time of hiring affect future remitted wages. The paper finds that the EWW is larger, more negative, and more persistent for more-educated workers conditional on being hired during a cyclical downturn.

Self-enforcing implicit wage contract. A labor contract in which the sequence of remitted wages is not pinned down period-by-period by spot-market forces but instead reflects an intertemporal risk-sharing arrangement between employer and worker that is sustained by the mutual benefit of the ongoing employment relationship. In this paper’s framework (drawing on Thomas and Worrall, 1988), lower separation rates make longer planning horizons feasible, which in turn expands the scope for deferring wage adjustments across time - effectively allowing more-educated workers and their employers to smooth the effects of cyclical shocks over longer horizons than is possible for less-educated workers with shorter expected job durations.

Cyclical sorting / match quality bias. The compositional concern that workers hired during recessions may be of systematically different (in this context, lower) match quality than those hired during booms, so that the persistent wage depression observed for recession hires could reflect poor match quality rather than cyclically sensitive wages for equivalent-quality matches. The paper uses the Hagedorn and Manovskii (2013) proxies - cumulated labor market tightness during the current job and prior employment history - to control for cyclical variation in match quality and assess the residual sensitivity of the UCL for average-quality matches.

Extensive versus intensive margin of labor market adjustment. The distinction between adjustment through changes in the number of workers employed (extensive margin: hiring and separation) versus adjustment through changes in wages or hours conditional on employment (intensive margin). A central finding of the paper is that less-educated workers bear cyclical adjustment disproportionately on the extensive margin (more volatile separation rates, employment losses following monetary contractions) while their wages are acyclical, whereas more-educated workers exhibit the reverse: stable employment but highly cyclically sensitive wages, especially as measured by the UCL.

Wage scarring. The persistent negative effect of hiring-period macroeconomic conditions on wages throughout the subsequent employment spell, beyond what is explained by contemporaneous market conditions. In this paper’s context, wage scarring is concentrated among more-educated workers: being hired when the unemployment rate is one percentage point above trend is associated with wages that remain depressed for several years, with the depression being larger and more persistent for college-educated workers than for those with less education. This is demonstrated via the expected wage wedge profiles in Figure 3 and is confirmed to survive controls for match-quality sorting.

Output-gap-equivalent representative agent economy. A conceptual benchmark constructed in the paper’s welfare analysis: a single-worker-type New Keynesian economy whose wage and labor supply elasticities are set equal to the output-elasticity-weighted averages of the two labor variety types in the heterogeneous economy. The paper shows that the heterogeneous-worker economy and this representative-agent benchmark produce identical aggregate output gap and price level paths (under Cobb-Douglas production, earnings elasticities are identical across varieties), but welfare diverges because period utility is more volatile for the variety with more rigid wages. The 15 percent excess welfare cost of the heterogeneous economy relative to this benchmark is the paper’s headline welfare result.