Credible Wage Bargaining and the Joint Dynamics of Unemployment and Inflation

Empirically, unemployment is highly volatile while inflation displays inertia, even though marginal cost is pro-cyclical. It was argued that real wage rigidities would no longer help replicate these facts, once firms determine employment and hours per worker. In this paper, real wage stickiness stems from wage bargaining with credible threat points, that we embed into a New Keynesian framework in which firms adjust both labor margins. This model notably reproduces the large jump in unemployment in the Great Recession. Moreover, inflation inertia is made consistent with pro-cyclical marginal cost since the credible bargaining induces strategic complementarities between firms.