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Labor Market Institutions and Aggregate Fluctuations in a Search and Matching Model

  • Francesco Zanetti

    (Bank of England)

This paper serves two purposes. First, it investigates to what extent a New Keynesian monetary model with the addition of a microfounded, non-Walrasian labor market based on union bargaining is able to replicate key aspects of the business cycle. Second, it explores the influence of this setting for the conduction of an optimal monetary policy in the specific class of Taylor-type rules. From a positive perspective, the presence of a representative union offers an explanation for two features of the cycle. Firstly, it generates an endogenous mechanism which produces persistent responses of the economy to both supply and demand shocks. Secondly, labor unionization reduces the elasticity of marginal costs to output. This leads to lower inflation volatility. Model simulations show the superiority of the unionized framework in reproducing European business cycle statistics relative to a model with a competitive labor market. From a normative standpoint, the union presence leads a welfare maximizing monetary authority to oppose output gap variations more strenuously and to attenuate reaction to inflation fluctuations compared with the competitive setting. Interest rate inertia preserves its welfare improving importance in a unionized labor market

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 445.

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Date of creation: 04 Jul 2006
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