Labor Market Search, Wage Bargaining and Inflation Dynamics

This paper integrates a theory of equilibrium unemployment into a monetary model
with nominal price rigidities. The model is used to study the dynamic response of the
economy to a monetary policy shock. The labor market displays search and matching
frictions and bargaining over real wages and hours of work. Search frictions generate unemployment in equilibrium. Wage bargaining introduces a microfounded real wage
rigidity. First, I study a Nash bargaining model. Then, I develop an alternative
bargaining model, which I refer to as right-to-manage bargaining. Both models have
similar predictions in terms of real wage dynamics: bargaining significantly reduces
the volatility of the real wage. But they have different implications for inflation
dynamics: under right-to-manage, the real wage rigidity also results in smaller
fluctuations of inflation. These findings are consistent with recent evidence
suggesting that real wages and inflation only vary by a moderate amount in
response to a monetary shock. Finally, the model can explain important features of
labor-market fluctuations. In particular, a monetary expansion leads to a rise in job
creation and to a hump-shaped decline in unemployment.