Working Paper: CEPR ID: DP4825
Authors: Roger E. A. Farmer
Abstract: Most dynamic stochastic general equilibrium models (DSGE) of the macroeconomy assume that labour is traded in a spot market. Two exceptions (Andolfatto [3], Merz [11]) combine the two-sided search model of Mortenson and Pissarides, [14], [13], [15] with a one-sector real business cycle model. These hybrid models are successful, in some dimensions, but they cannot account for observed volatility in unemployment and vacancies. Following a suggestion by Hall, [4] [5], building on work by Shimer [18], this Paper shows that a relatively standard DSGE model with sticky wages can account for these facts. Using a second-order approximation to the policy function I simulate moments of an artificial economy with and without sticky wages. I compute the welfare costs of the sticky wage equilibrium and find them to be small.
Keywords: No keywords provided
JEL Codes: E24; E32; J63; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| traditional DSGE models with flexible wages (E13) | observed volatility in unemployment and vacancies (J69) |
| sticky wages (J31) | cyclical features of employment, investment, consumption, and output (E32) |
| sticky wage equilibrium (J31) | small welfare costs (D69) |
| sticky wages (J31) | countercyclical nature of unemployment (J64) |
| sticky wages (J31) | procyclical behavior of vacancies (J69) |