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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: https://www.uvic.ca/socialsciences/economics/_assets/docs/discussion/ddp1303.pdf
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    References listed on IDEAS

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    1. 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 Kiel).
    2. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
    3. Shi, Shouyong, 1998. "Search for a Monetary Propagation Mechanism," Journal of Economic Theory, Elsevier, vol. 81(2), pages 314-352, August.
    4. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
    5. 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.
    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. Alfred A. Haug & Ian P. King, 2011. "Empirical Evidence on Inflation and Unemployment in the Long Run," Department of Economics - Working Papers Series 1128, The University of Melbourne.
    2. Shoujian Zhang, 2014. "Search Frictions, Job Flows and Optimal Monetary Policy," CDMA Working Paper Series 201402, Centre for Dynamic Macroeconomic Analysis.

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    More about this item

    Keywords

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

    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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