Endogenous Labor Supply in an Estimated New-Keynesian Model: Nominal versus Real Rigidities

Standard macroeconomic models find it difficult to reconcile slow recoveries and missing disinflations after deep deteriorations in the labor market. We develop and estimate a New-Keynesian model with search and matching frictions in the labor market, endogenous intensive and extensive labor supply decisions, and financial frictions. We conclude that the estimated combination of a low degree of nominal wage rigidities and a high degree of real wage rigidities, together with a small role for pre-match costs relative to post-match costs, is key in successfully forecasting slow recoveries in unemployment and missing disinflations in the aftermath of recessions, such as the Great Recession. We find that data on endogenous labor supply decisions (participation and hours) are very informative about the relative degree of nominal and real wage rigidities and the slope of the Phillips curve. We also show that none of the model-based labor market gaps are a sufficient statistic of labor market slack, but all contain relevant information about the state of the economy summarized in a new indicator for labor market slack that we propose.