HT - 06. Labour Market Frictions Flashcards
Gali (2011)
Aim: introduce variable labour market participation, which acts as another unemployment shifter (with employment). Eg. Negative shock –> Lower real wages –> Negative income effect –> increase participation n_t –> worsening of unemployment: u_t=l_t-n_t
Conclusion:
Quantitatively realistic LM frictions –> Limited effect of equilibrium dynamics….instead they make room for wage rigidities which give inefficient responses and significant MP trade-offs
Sticky wages bargained over –> Optimal MP deviates from full price stability –> Well approximated by simple interest rate rule with high coefficient 1.5 on price inflation
Deviations in unemployment from efficient level give inefficiencies –> optimal rule has weak systematic response to unemployment fluctuations
Topic Summary ()
- RBC model unemployment is all voluntary, empirical evidence suggests wages adjust slowly so introduce diversified labour inputs (eg. Skill sets) but monopolistic power –> Equilibrium unemployment: marginal participant (last person wanting to work) – employment
- Wage Phillips curve – links wage inflation to MRS gap which is a wedge between real wage and MRS due to monopoly power
- Real wage gap implies a relationship between wage and price inflation
• Full stabilisation of price inflation ≠ Optimal monetary policy
o Optimal MP now targets a combination of stabilising price and wage inflation –> relative stickiness pins weights
o Only wages sticky –> optimal rule trades off wage inflatoin and output gap
o Now 3 sources of inefficiencies giving welfare losses to HH: new one is sluggish response of wages to shocks creating inefficient variations in average wage markup
o Wage inflation + staggered wage setting = Relative wage distortions
• Wage phillips curve has similar intuition to price phillips curve
o If average wage is below thw wage consistent with maintaining desired markup –> Workers who can re-set will increase nominal wages –> Generating positive wage inflation
o Imperfect adjustment –> Avereage real wage does NOT more 1:1 with MRS –> Variations in average markup and wage inflation
• Full stabilisation NOT possible now, even if the natural real rate can be observed for all t
Flex price equilibrium ≠ attainable with rigid wages AND prices
o Optimal policy balances attaining output and real wage adjustments and keeping wage and price inflation close to 0 to aoivd distortions of nominal instability
• Possible search frictions as a microfoundation, encorporating this into an NKM is not enough –> “Shimer Puzzle”: employment too smooth and wages to volatile –> need more frictions eg. Sticky wages
o Output response even weaker than in NKM with competitive LM
• Unemployment in the NKM
o Labour market power –> positive wage markup –> existence of unemployment (even w/o wage rigidities)
o Wage rigidities –> Variations in the wage markup –> Variations in unemployment
