DP15833 When Hosios meets Phillips: Connecting efficiency and stability to demand shocks

Author(s): Nicolas Petrosky-Nadeau, Etienne Wasmer, Philippe Weil
Publication Date: February 2021
Keyword(s): aggregate demand, constrained efficiency, market power, Search and matching frictions, unemployment, Wage Phillips Curve
JEL(s): E24, E32, J63, J64
Programme Areas: Labour Economics, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15833

In an economy with frictional goods and labor markets there exist a price and a wage that implement the constrained efficient allocation. This price maximizes the marginal revenue of labor, balancing a price and a trading effect on firm revenue, and this wage trades off the benefits of job creation against the cost of turnover in the labor market. We show under bargaining over prices and wages that a double Hosios condition: (i) implements the constrained efficient allocation; (ii) also minimizes the elasticity of labor market tightness and job creation to a demand shock, and; (iii) that the relative response of wages to that of unemployment to changes in demand flattens as workers lose bargaining power, and it is steepest when there is efficient rent sharing in the goods market between consumers and producers, thereby relating changes in the slope of a wage Phillips curve to the constrained efficiency of allocations.