This paper develops and estimates a quantitative macroeconomic framework that incorporates labor market frictions. Our starting point is the now conventional monetary DSGE model developed by Christiano, Eichenbaum and Evans (CEE, 2005), Smets and Wouters (SW, 2007) and others. We introduce labor market frictions with a variant of the Mortensen and Pissarides search and matching framework. This variant allows for staggered Nash wage bargaining, as in Gertler and Trigari (GT, 2006).
Our motivation is two fold. First, there are some compelling theoretical considerations. The recent vintage of monetary DSGE models typically has employment adjusting on the intensive margin along with staggered nominal wage contracting. The latter feature, further, is important for the quantitative performance of the model: The wage stickiness helps accounting for the volatility of hours. However, as a consequence, these frameworks are susceptible to Barro’s (1977) argument that wages may not be allocational in this kind of environment, given that firms and workers have an on-going relationship.
If wages are not allocational then wage rigidity does not influence model dynamics. By contrast, in the model we present, firms adjust employment along the extensive margin. In this instance, wage rigidity affects employment by influencing the rate at which firms add new workers to their respective labor forces. As emphasized by Hall (2005a), since new workers have yet to form on-going relationships with firms, in this kind of setting the Barro’s critique does not apply.
Second, within the search and matching literature, there is a debate over how well the baseline Mortensen and Pissarides framework can account for labor market volatility, or whether it may be necessary to introduce additional features such as wage rigidity, etc. (e.g. Shimer, 2005, Hall, 2005a, Hagedorn and Manovskii, 2006, Mortensen and Nagypal, 2007). A typical approach in the literature has been to develop a calibrated model, subject it to productivity shocks, and then examine model moments against moments of the data, with various features such as wage rigidity or on-the-job search shut on and then shut off. We instead estimate a complete macroeconomic framework using Bayesian methods. Doing so allows us to formally evaluate the significance of different mechanisms such as wage rigidity to overall model performance. In addition, our full information procedure permits us to account for the complete range of shocks that hit the economy.
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An Estimated Monetary DSGE Model with Unemployment and Staggered Nominal Wage Bargaining
