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Real Price and Wage Rigidities in a Model with Matching Frictions

  • Keith Kuester
  • Goethe University

I reconcile macro- and micro-evidence on price setting in a search and matching framework. Search frictions lead price-setting firms to negotiate wage rates with their employees. In contrast to the existing macro-labor literature, I assume that wage-bargaining and price-setting occur in the same sector. The degree of strategic complementarity of price-setting thus increases, leading to substantial real price rigidities which in turn reduce implied price durations. At the same time this mechanism dampens the reaction of real wage rates to aggregate fluctuations which is necessary to explain the highly volatile response of vacancies in the data. A further interesting finding is that inflation via the Phillips curve is not only driven by an output gap but also by an employment gap – a feature usually neglected in empirical research. I demonstrate that the modified model fits impulse responses to monetary policy shocks obtained from a structural VAR for post Volcker-disinflation U.S. data very well.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 152.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:152
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