Hiring and Investment Frictions as Inflation Determinants

We embed convex hiring and investment frictions in a New Keynesian DSGE model with intra-firm wage bargaining. We show that these frictions have crucial implications for the response of marginal costs, and consequently inflation; and for the co-movement of inflation with real variables. We elucidate how the presence of hiring and investment frictions affects the transmission mechanism of monetary and technological shocks by means of impulse responses. We find that hiring frictions are a key determinant of current period marginal costs; investment frictions also matter, by affecting expectations of future marginal costs. Estimating the model with private-sector US data shows that both hiring frictions and investment frictions help explain inflation dynamics. Smoothed estimates of marginal costs are radically different in models with and without hiring frictions. Our results indicate that hiring frictions explain around 50% of the variation in marginal costs, the real wage component explains around 35% while the remain 15% is accounted for by an intrafirm bargaining component. These estimates rely only on moderate levels of the relevant frictions.