Optimal monetary policy in economies with dual labor markets

Abstract

We present a DSGE New Keynesian model with indivisible labor and a dual labor market: a walrasian one where wages are fully ‡exible and a unionized one charaterized by real wage rigidity. We show that the negative e¤ect of a productivity shock on in ‡ation and the positive e¤ect of a cost-push shock are crucially determined by the proportion of …rms that belong to the unionized sector. The larger this number, the larger are these e¤ects. Consequently, the larger the union coverage, the larger should be the optimal response of the nominal interest rate to exogenous productivity and cost-push shocks. The optimal in ‡ation and output gap volatility increases as the number of the unionized …rms in the economy increases. JEL codes: E24, E32, E50, J23, J51

Cyclicality of wages and union power

“…At the time of bargaining, 1 − u t workers are employed, and all these workers will reach the payo W t with certainty at the 8 See Zanetti (2011), Mattesini andRossi (2009), andFaia andRossi (2013) for models with monopoly unions.…”

“…In this sense, my paper is related to a small literature that studies the business cycle in settings that depart from perfect competition in the labor market. Mattesini and Rossi (2009) and Faia and Rossi (2013) analyze optimal monetary policy rules in a unionized or dual labor market economy, whereas Zanetti (2007) develops a DSGE model with the addition of a unionized labor market to analyze the macroeconomic responses to demand and supply shocks. In these three papers, unions dampen wage dynamics because union wages are assumed to depend on either exogenous union reservation wages or past wages, two assumptions that creates ad hoc wage rigidity.…”

“…5 In Mattesini and Rossi (2009), union wages are totally acyclical due to the additional assumption of a Stone-Geary utility function of the union. occurs with a level of employment n t , and salaries w t and unemployment benets b are paid.…”

Monetary Policy and Automatic Stabilizers: The Role of Progressive Taxation

“…It is important to notice that in this model the endogenous trade‐off between inflation stabilization and output stabilization arises without any assumption on real wage rigidity as in Blanchard and Galì (2007), or on the structure of labor contracts as in Mattesini and Rossi (2009). Rather, it is a simple consequence of the structure of taxation that, in most countries, shows some degree of progressivity.…”

“…Although these authors simply assume that the current real wage is a function of the past real wage. Mattesini and Rossi (2009) show that a significant policy trade‐off arises also in a two sector economy were one of the two sectors is unionized.…”