Do entry wages increase when severance pay drops? Not in recessions

Severance pay may generate employment effects if wages are rigid. We study this by analysing a reform introduced during a recession that reduced severance pay for new hires while leaving it unchanged for previously-hired employees. We exploit this grandfathering dimension using a regression-discontinuity approach and long monthly data. We find that entry wages did not increase following the reduction in severance. This suggests that severance adjustments over the business cycle may reduce employment fluctuations.

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