The Role of Real Wage Rigidity and Labor Market Frictions for Inflation Persistence

We analyze the transmission mechanism of wages to inflation within a New Keynesian business cycle model with wage rigidities and labor market frictions. Our main focus is on the channel of real wage rigidities on inflation persistence for which we find the specification of the wage bargaining process to be of crucial importance. Under the standard efficient Nash bargaining, the feedback of wage rigidities on inflation is ambiguous and depends on other labor market variables. However, under the alternative right‐to‐manage bargaining we find that more rigid wages translate directly into more persistent movements of aggregate inflation.     

The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions

We develop a New Keynesian model with search and matching frictions in the labor market. We show that the model generates counterfactual labor market dynamics. In particular, it fails to generate the negative correlation between vacancies and unemployment in the data, i.e., the Beveridge curve. Introducing real wage rigidity leads to a negative correlation, and increases the magnitude of labor market flows to more realistic values. However, inflation dynamics are only weakly affected by real wage rigidity. The reason is that labor market frictions give rise to long-run employment relationships. The measure of real marginal costs that is relevant for inflation in the Phillips curve contains a present value component that varies independently of the real wage.     

Monetary Policy,Trend Inflation,and Unemployment Volatility

The literature has long agreed that the DMP model (after Diamond 1982, Mortensen 1982, Pissarides 1985) with search and matching frictions in the labor market can deliver large volatilities in labor market quantities, consistent with empirical data, only if there is at least some wage stickiness. I show, however, that the model can deliver nontrivial volatilities without wage stickiness, as long as it has price dispersion and nonzero long‐run inflation rates. I find that by keeping inflation at a positive rate, monetary policy may be accountable for the large standard deviations observed on labor market variables. In addition, the Shimer (2005) puzzle disappears under monetary policy shocks.     

Labor market reform and price stability: An application to the Euro Area

Central bankers frequently suggest that labor market reform may be beneficial for inflation management. This paper investigates this topic by simulating the effects of reductions in firing costs and unemployment benefits on inflation volatility in the Euro Area, using an estimated New Keynesian model with search and matching frictions. Qualitatively, changes in labor market policies alter the volatility of inflation in response to shocks, by affecting the volatility of the three components of real marginal costs (hiring costs, firing costs and wage costs). Quantitatively, we find, however, that neither policy is likely to have an important effect on inflation volatility, due to the small contribution of hiring and firing costs to inflation dynamics.     

An Open Economy DSGE Model with Search-and-Matching Frictions: The Case of Hungary

This article builds and estimates a medium scale, small open economy DSGE model augmented with search-and-matching frictions in the labor market, and different wage setting behavior in new and existing jobs. The model is estimated using Hungarian data between 2001–2008. We find that: (i) the inclusion of matching frictions significantly improves the model’s empirical fit; (ii) the extent of new hires wage rigidity is quantitatively important for key macro variables; (iii) labor market shocks do not play an important role in inflation dynamics, but the structure of the labor market influences the monetary transmission mechanism.     

Optimal Monetary Policy with Labor Market Frictions: The Role of the Wage Channel

This paper introduces right‐to‐manage bargaining into a labor search model with sticky prices instead of standard efficient bargaining and examines the Ramsey‐optimal monetary policy. Without real wage rigidity, even when the steady state is inefficient, price stability is nearly optimal in response to technology or government shocks. Right‐to‐manage bargaining creates the wage channel to inflation, because there is a direct relationship between real wages and real marginal cost. In the presence of the wage channel, price markups consist of only real marginal cost, and real wages and hours per worker are determined such as in the Walrasian labor market.     

Asymmetric Labor Market Institutions in the EMU and the Volatility of Inflation and Unemployment Differentials

How does the asymmetry of labor market institutions affect the adjustment of a currency union to shocks? To answer this question, this paper sets up a dynamic currency union model with monopolistic competition and sticky prices, hiring frictions, and real wage rigidities. In our analysis, we focus on the differentials in inflation and unemployment between countries, as they directly reflect how the currency union responds to shocks. We highlight the following three results. First, we show that it is important to distinguish between different labor market rigidities as they have opposite effects on inflation and unemployment differentials. Second, we find that asymmetries in labor market structures tend to increase the volatility of both inflation and unemployment differentials. Finally, we show that it is important to take into account the interaction between different types of labor market rigidities. Overall, our results suggest that asymmetries in labor market structures worsen the adjustment of a currency union to shocks.     

How Do Nominal and Real Rigidities Interact? A Tale of the Second Best

This paper analyzes the importance of real wage rigidities, in particular through their interaction with price stickiness, in a New Keynesian model. Real wage rigidities result from a combination of staggered wage setting and partial indexation of nonreset wages to past inflation. Blanchard and Galí (2007) show real rigidities to introduce a trade‐off between stabilizing inflation and the welfare‐relevant output gap. The present paper complements their findings by showing that the welfare costs of real rigidities can be substantial compared to nominal frictions. In a typical “tale of the second best,” we also show that in the presence of real wage rigidities, higher price stickiness can be welfare enhancing.     

Search Frictions,Real Rigidities,and Inflation Dynamics

The literature on New Keynesian models with search frictions in the labor market commonly assumes that price setters are not actually subject to such frictions. Here, I propose a model where firms are subject both to infrequent price adjustment and search frictions. This interaction gives rise to real price rigidities, which have the effect of slowing down the adjustment of the price level to shocks. This has a number of consequences for equilibrium dynamics. First, inflation becomes less volatile and more persistent. More importantly, the model’s empirical performance improves along its labor market dimensions, such as the size of unemployment fluctuations and the relative volatility of the two margins of labor.     

Downward wage rigidity and business cycle asymmetries

The growth rates of wages, unemployment and output of a number of OECD countries have a strongly skewed distribution. In this paper we analyze to what extent downward wage rigidities can explain these empirical business cycle asymmetries. To this aim, we introduce asymmetric wage adjustment costs in a New-Keynesian DSGE model with search and matching frictions in the labor market. Increasing wages is less costly than cutting them. It follows that wages increase relatively fast and thus limit vacancy posting and employment creation, but they decline more slowly, leading to a strong reduction in vacancies and employment. The presence of downward wage rigidities strongly improves the fit of the model to the observed skewness of labor market variables and the relative length of expansions and contractions in the output and the employment cycles. The asymmetry also explains the differing transmission of positive and negative monetary policy shocks from wages to inflation.     

劳动市场摩擦与机会主义货币政策

本文在存在劳动市场摩擦的DSGE模型框架下考察机会主义货币政策的合理性。研究发现,当经济中存在显著的工资粘性、雇佣成本和搜寻匹配摩擦时,实行灵活通胀目标的机会主义货币政策在社会福利效果上优于以稳定通胀和产出缺口为目标的标准泰勒规则,并接近无约束最优政策的福利效果。因此在这些条件下,机会主义货币政策是中央银行合理的政策选择。     

Inflation dynamics with search frictions: A structural econometric analysis

The New Keynesian Phillips curve explains inflation dynamics as being driven by current and expected future real marginal costs. In competitive labor markets, the labor share can serve as a proxy for the latter. In this paper, we study the role of real marginal cost components implied by search frictions in the labor market. We construct a measure of real marginal costs by using newly available labor market data on worker finding rates. Over the business cycle, the measure is highly correlated with the labor share. Estimates of the Phillips curve using generalized method of moments reveal that the marginal cost measure remains significant, and that inflation dynamics are mainly driven by the forward-looking component. Bayesian estimation of the full New Keynesian model with search frictions helps us disentangle which shocks are driving the economy to generate the observed unit labor cost dynamics. We find that mark-up shocks are the dominant force in labor market fluctuations.     

Understanding the Distributional Impact of Long‐Run Inflation

The impact of fully anticipated inflation is systematically studied in heterogeneous agent economies with an endogenous labor supply and portfolio choices. In stationary equilibrium, inflation nonlinearly alters the endogenous distributions of income, wealth, and consumption. Small departures from zero inflation have the strongest impact. Three features determine how inflation impacts distributions and welfare: financial structure, shock persistence, and labor supply elasticity. When agents can self‐insure only with money, inflation reduces wealth inequality but may raise consumption inequality. Otherwise, inflation reduces consumption inequality but may raise wealth inequality. Given persistent shocks and an inelastic labor supply, inflation may raise average welfare. The results hold when the model is extended to account for capital formation.     

Technology shocks and labor market dynamics: Some evidence and theory

A positive technology shock may lead to a rise or a fall in per capita hours, depending on how hours enter the empirical VAR model. We provide evidence that, independent of how hours enter the VAR, a positive technology shock leads to a weak response in nominal wage inflation, a modest decline in price inflation, and a modest rise in the real wage in the short-run and a permanent rise in the long-run. We then examine the ability of several competing theories to account for this VAR evidence. Our preferred model features sticky prices, sticky nominal wages, and habit formation. The same model also does well in accounting for the labor market evidence in the post-Volcker period.     

Inflation and productive activity in a multiple-matching model of money

This paper investigates the relationship between money growth, inflation, and productive activity in a dynamic general-equilibrium, multiple-matching framework where trade frictions are manifested by limited consumption variety. Productive activity and matching in the goods market are endogenized by a time allocation decision of work and search effort. We find that a high degree of complementarity between participation in the labor and goods markets creates a channel by which inflation can positively influence production and output. This feature arises when household preferences for consumption variety is sufficiently large and it can also lead to the multiplicity of monetary equilibria.     

A Phillips Curve with Anchored Expectations and Short‐Term Unemployment

This paper examines the behavior of U.S. core inflation, as measured by the weighted median of industry price changes. We find that core inflation since 1985 is well‐explained by an expectations‐augmented Phillips curve in which expected inflation is measured with professional forecasts and labor‐market slack is captured by the short‐term unemployment rate. We also find that expected inflation was backward‐looking until the late 1990s, but then became strongly anchored at the Federal Reserve's target. This shift in expectations changed the relationship between inflation and unemployment from an accelerationist Phillips curve to a level‐level Phillips curve. Our specification explains why high unemployment during the Great Recession did not reduce inflation greatly: partly because inflation expectations were anchored, and partly because short‐term unemployment rose less sharply than total unemployment.     

Inflation and Welfare in Long‐Run Equilibrium with Firm Dynamics

We analyze the welfare cost of inflation in a model with a cash‐in‐advance constraint and an endogenous distribution of establishments' productivities. Inflation distorts aggregate productivity through firm entry dynamics. The model is calibrated to the U.S. economy and the long‐run equilibrium properties are compared at low and high inflation. When the period over which the cash‐in‐advance constraint is binding is one quarter, an annual inflation rate of 10% leads to a decrease in average productivity of roughly 0.5% compared to the optimum. This decrease is not innocuous: it leads to a doubling of the welfare cost of inflation.     

Monetary Policy,Asset Prices,and Liquidity in Over‐the‐Counter Markets

We develop a model where agents can allocate their wealth between a liquid asset, which can be used to purchase consumption goods, and an illiquid asset, which represents a better store of value. Should a consumption opportunity arise, agents may visit a frictional “over‐the‐counter” secondary asset market where they can exchange illiquid for liquid assets. We characterize how monetary policy affects both the issue price and the secondary market price of the asset. We also show that, in contrast to conventional wisdom, search and bargaining frictions in the secondary asset market can improve welfare if inflation is low.     

Welfare Cost of Fluctuations When Labor Market Search Interacts with Financial Frictions

We study the welfare costs of business cycles in a search and matching model with financial frictions. The model replicates the volatility on labor and financial markets. Business cycle costs are sizable. Indeed, the interactions between labor market and financial frictions magnify the impact of shocks via (i) a credit multiplier effect and (ii) an endogenous wage rigidity inherent to financial frictions. In addition, in a nonlinear framework, large welfare costs of fluctuations are explained by the high average unemployment and the low job finding rates with respect to their deterministic steady‐state values.     

Optimal monetary policy in an economy with incomplete markets and idiosyncratic risk

This study investigates an incomplete markets economy in which the saving behavior of a continuum of infinitely lived agents is influenced by precautionary saving motives and borrowing constraints. Agents can use two types of assets (interest bearing IOUS and money) to smooth consumption. Money is valued because of a timing friction in the bond market. In particular, the bond market closes before agents observe their idiosyncratic productivity shock. I find that the Friedman rule is not optimal for this economy. The results indicate that the optimal allocation has a rate of inflation of 10%, and a positive amount of private credit held by the government. A positive inflation rate transfers resources from agents with big endowments to those holding bonds which improves risk sharing, and therefore, welfare. However, for higher rates of inflation, agents economize on money holdings, offsetting the insurance effects, and causing a reduction in welfare. Furthermore, higher rates of inflation discourage agents from borrowing, and the endogenous lower bound on bond holdings is higher than the exogenous borrowing limit. High rates of inflation, therefore, exacerbate frictions in the bond market.