Labour market imperfections, "divine coincidence" and the volatility of employment and inflation

Abstract

The dynamic general equilibrium model with hiring costs presented in this paper delivers involuntary unemployment in the steady state as well as involuntary fluctuations in unemployment. The existence of hiring friction introduces externalities that, in turn, entail the breakdown of the "divine coincidence" without assuming real wage rigidity. Our model with labour market imperfections outperforms the standard NK model as for the persistence of responses to monetary shocks. The model also allows for an analysis of the volatility of economies, differing in their "degrees of labour market rigidity". It turns out that "rigid" economies exhibit less unemployment volatility and more inflation volatility than "flexible" economies.Hiring Costs, Wage Bargaining, Output Gap, New Keynesian Phillips Curve