Labour Market Search, Wage Bargaining and Inflation Dynamics

This paper integrates a theory of equilibrium unemployment into a monetary model with nominal price rigidities. The model is used to study the dynamic response of the economy to a monetary policy shock. The labor market displays search and matching frictions and bargaining over real wages and hours of work. Search frictions generate unemployment in equilibrium. Wage bargaining introduces a microfounded real wage rigidity. First, I study a Nash bargaining model. Then, I develop an alternative bargaining model, which I refer to as right-to-manage bargaining. Both models have similar predictions in terms of real wage dynamics: bargaining significantly reduces the volatility of the real wage. But they have different implications for inflation dynamics: under right-to-manage, the real wage rigidity also results in smaller fluctuations of inflation. These findings are consistent with recent evidence suggesting that real wages and inflation only vary by a moderate amount in response to a monetary shock. Finally, the model can explain important features of labor-market fluctuations. In particular, a monetary expansion leads to a rise in job creation and to a hump-shaped decline in unemployment.