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Labor Markets, Unemployment and Optimal Inflation

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Abstract

The optimal infation rate and the relationship between inflation and unemployment are central issues in macroeconomics. It is widely accepted that inflation is a monetary phenomenon. However, there is little consensus with regard to unemployment. Economists differ widely in their view of labor markets and wage-setting mechanisms. The present paper develops a search-theoretic monetary model with imperfect labor markets. It studies the issue of the optimal inflation rate and the relationship between inflation and unemployment under four widely used wage-setting mechanisms: search and matching, wage posting, union bargaining, and efficiency wage. It finds that a higher inflation rate reduces output and employment under all wage setting mechanisms. The Friedman rule is not optimal under any wage setting mechanism except wage posting.

Suggested Citation

  • Alok Kumar, 2013. "Labor Markets, Unemployment and Optimal Inflation," Department Discussion Papers 1303, Department of Economics, University of Victoria.
  • Handle: RePEc:vic:vicddp:1303
    Note: ISSN 1914-2838
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    File URL: http://www.uvic.ca/socialsciences/economics/assets/docs/discussion/ddp1303.pdf
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    References listed on IDEAS

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    1. Shi, Shouyong, 1998. "Search for a Monetary Propagation Mechanism," Journal of Economic Theory, Elsevier, vol. 81(2), pages 314-352, August.
    2. Benoit Julien & John Kennes & Ian King, 2000. "Bidding for Labor," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(4), pages 619-649, October.
    3. Berentsen, Aleksander & Menzio, Guido & Wright, Randall D., 2007. "Inflation and Unemployment: Lagos-Wright meets Mortensen-Pissarides," Kiel Working Papers 1334, Kiel Institute for the World Economy (IfW).
    4. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
    5. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
    6. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
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    Cited by:

    1. Haug, Alfred A. & King, Ian P., 2011. "Empirical evidence on inflation and unemployment in the long run," MPRA Paper 33409, University Library of Munich, Germany.
    2. Shoujian Zhang, 2014. "Search Frictions, Job Flows and Optimal Monetary Policy," CDMA Working Paper Series 201402, Centre for Dynamic Macroeconomic Analysis.

    More about this item

    Keywords

    search-theoretic monetary model; inflation; unemployment; Friedman Rule; search and matching; wage posting; unions; efficiency wage;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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