DP4825 Shooting the Auctioneer

Author(s): Roger E A Farmer
Publication Date: January 2005
Keyword(s):
JEL(s): E24, E32, J63, J64
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4825

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.