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The role of real wage rigidity and labor market frictions for unemployment and inflation dynamics

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Author Info
Kai Christoffel () (Correspondence to: European Central Bank, Postfach 160319, 60066 Frankfurt am Main, Germany)
Tobias Linzert () (European Central Bank, Postfach 160319, 60066 Frankfurt am Main, Germany)

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Abstract

In this paper we incorporate a labor market with matching frictions and wage rigidities into the New Keynesian business cycle model. In particular, we analyze the effect of a monetary policy shock and investigate how labor market frictions affect the transmission process of monetary policy. The model allows real wage rigidities to interact with adjustments in employment and hours affecting inflation dynamics via marginal costs. We find that the response of unemployment and inflation to an interest rate innovation depends on the degree of wage rigidity. Generally, more rigid wages translate into more persistent movements of aggregate inflation. Moreover, the impact of a monetary policy shock on unemployment and inflation depends also on labor market fundamentals such as bargaining power and the flows in and out of employment.

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Paper provided by European Central Bank in its series Working Paper Series with number 556.

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Length: 40 pages
Date of creation: Nov 2005
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Handle: RePEc:ecb:ecbwps:20050556

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Related research
Keywords: Monetary Policy; Matching Models; Labor Market Search; Inflation Persistence; Real Wage Rigidity.;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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