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Inflation Dynamics and Labor Market Dynamics Revisited

  • Tommy Sveen
  • Lutz Weinke

Firms adjust labor both at the intensive and at the extensive margin (see, e.g., Hansen and Sargent 1988). Moreover, employment adjustment is not frictionless (see, e.g., Mortensen and Pissarides 1994). What does this imply for inflation dynamics? To address this question we develop a New Keynesian model featuring two margins of labor adjustment as well as a simultaneous price-setting and employment decision at the firm level. We find that the presence of an empirically plausible labor adjustment decision at the firm level rationalizes strategic complementarities in price-setting which help explain in‡ation dynamics.

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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1368.

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Length: 27 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:kie:kieliw:1368
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