The Business Cycle with Nominal Contracts and Search Frictions

Moon, Weh-Sol (2011): The Business Cycle with Nominal Contracts and Search Frictions.

Abstract

I construct a dynamic stochastic general equilibrium (DSGE) model characterized by flexible prices, search frictions, and nominal wage contracts, and examine to what extent the model can explain the quantitative business cycle properties of real macroeconomic variables in the U.S. economy. I consider efficient bargaining that the firm and the worker enter into bargaining over the future nominal hourly wage rate and future hours worked under the generalized Nash bargaining framework. The Nash product is assumed to consist of the discounted present value of the expected match surplus. Under efficient bargaining, the model hardly produces unrealistically high volatility of real variables or countercyclical productivity because hours per worker are fixed ahead of time and employment is a slow-moving variable with search frictions. Moreover, efficient bargaining requires firms to rely on job creation heavily to adjust the wedge between the marginal product of labor and the real wage rate in response to shocks. As contract length increases, the volatilities of the unemployment rate and vacancy rate increase significantly, but those of output and total hours worked do not appreciably change. I also investigate the model under different assumptions such as the right-to-manage approach, the Nash product with the current value of match surplus, and instantaneous hiring. Efficient and forward-looking bargaining are important in accounting for the U.S. business cycle properties.

• Item Type: MPRA Paper
• Language: English
• Keywords: Business Cycles, Search Frictions, Nominal Wage Contracts, Efficient Bargaining
• Subjects: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E24 - Employment ; Unemployment ; Wages ; Intergenerational Income Distribution ; Aggregate Human Capital ; Aggregate Labor Productivity; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles

References

Andolfatto, David (1996) Business cycles and labor-market search. American Economic Review 86, 112-132.

Bils, Mark and Yongsung Chang (2003) Welfare costs of sticky wages when effort can respond. Journal of Monetary Economics 50, 311-330.

Blanchard, Olivier J. and Stanley Fischer (1989) Lectures on Macroeconomics. Cambridge, MA: MIT Press.

Blanchard, Olivier J. and Jordi Gali (2010) Labor markets and monetary policy: a new Keynesian model with unemployment. American Economic Journal: Macroeconomics 2, 1-30.

Chang, Yongsung and Sun-Bin Kim (2006) From individual to aggregate labor supply: a quantitative analysis based on a heterogeneous agent macroeconomy. International Economic Review 47, 1-27.

Cho, Jang-Ok (1993) Money and business cycle with one-period nominal contracts. Canadian Journal of Economics 26, 638-659.

Cho, Jang-Ok, and Thomas F. Cooley (1995) The business cycle with nominal contracts. Economic Theory 6, 13-33.

Cho, Jang-Ok, Thomas F. Cooley, and Louis Phaneuf (1997) The welfare cost of nominal wage contracting. Review of Economic Studies 64, 465-484.

Christoffel, Kai and Keith Kuester (2008) Resuscitating the wage channel in models with unemployment fluctuations. Journal of Monetary Economics 55, 865-887.

Christoffel, Kai, James Costain, Gregory de Walque, Keith Kuester, Tobias Linzert, Stephen Millard, and Olivier Pierrard (2009) Wage inflation and employment dynamics with labour market matching. Documentos de Trabajo No. 0918, Banco de Espana.

Christoffel, Kai, and Tobias Linzert (2010) The role of real wage rigidity and labor market frictions for inflation persistence. Journal of Money, Credit and Banking, 42(7), 1435-1446.

Cole, Harold L. and Richard Rogerson (1999) Can the Mortensen-Pissarides matching model match the business-cycle facts? International Economic Review 40, 933-959.

Cooley, Thomas F. and Gary D. Hansen (1989) The inflation tax in a real business cycle model. American Economic Review 79, 733-748.

Cooley, Thomas F. and Gary D. Hansen (1995) Money and the business cycle. In Cooley, T. F. (ed.), Frontiers of Business Cycle Research, pp.175-216. Princeton, New Jersey: Princeton University Press.

Cooley, Thomas F. and Vincenzo Quadrini (1999) A neoclassical model of the Phillips curve relation. Journal of Monetary Economics 44, 165-193.

Fischer, Stanley (1977) Long-term contracts, rational expectations, and the optimal money supply rule. Journal of Political Economy 85(1), 191-205.

Gali, Jordi (2010) Monetary policy and unemployment. In Benjamin M. Friedman and Michael Woodford (ed.), Handbook of Monetary Economics, pp. 487-546. Amsterdam: Elsevier.

Gertler, Mark, Luca Sala, and Antonella Trigari (2008) An estimated monetary DSGE model with unemployment and staggered nominal wage bargaining. Journal of Money, Credit and Banking 40, 1713-1764.

Gertler, Mark and Antonella Trigari (2009) Unemployment fluctuations with staggered Nash wage bargaining. Journal of Political Economy 117, 38-86.

Gray, Jo A. (1976) Wage indexation: a macroeconomic approach. Journal of Monetary Economics 2, 221-235.

Hagedorn, Marcus, and Iourii Manovksii (2008) The cyclical behavior of equilibrium unemployment and vacancies revisited. American Economic Review 98(4), 1692-1706.

Hall, Robert E. (2005) Employment fluctuations with equilibrium wage stickiness. American Economic Review 95, 50-65.

Ireland, Peter N. (2003) Endogenous money or sticky prices? Journal of Monetary Economics 50, 1623-1648.

Janko, Zuzana (2008) Nominal wage contracts, labor adjustment costs and the business cycle. Review of Economic Dynamics 11, 434-448.

Krause, Michael U. and Thomas A. Lubik (2007) The (ir)relevance of real wage rigidity in the new Keynesian model with search frictions. Journal of Monetary Economics 54, 706-727.

Krause, Michael U., David Lopez-Salido, and Thomas A. Lubik (2008) Inflation dynamics with search frictions: A structural econometric analysis. Journal of Monetary Economics 55(5), 892-916.

Merz, Monika (1995) Search in the labor market and the real business cycle. Journal of Monetary Economics 36, 269-300.

Mortensen, Dale T. and Christopher A. Pissarides (1994) Job creation and job destruction in the theory of unemployment. Review of Economic Studies 61, 397-415.

Shimer, Robert (2005) The cyclical behavior of equilibrium unemployment and vacancies. American Economic Review 95, 25-49.

Thomas, Carlos (2008) Search and matching frictions and optimal monetary policy. Journal of Monetary Economics 55, 936-956.

Trigari, Antonella (2006) The role of search frictions and bargaining of inflation dynamics. IGIER Working Paper No. 304, Bocconi University.

Veracierto, Marcelo (2008) On the cyclical behavior of employment, unemployment and labor force participation. Journal of Monetary Economics 55, 1143-1157.

Yun, Tack (1996) Nominal price rigidity, money supply endogeneity, and business cycles. Journal of Monetary Economic 37, 345-370.