The Business Cycle with Nominal Contracts and Search Frictions

I construct a dynamic stochastic general equilibrium (DSGE) model characterized by flexible prices, search frictions, and nominal wage contracts, and examine to what extent the model can explain the quantitative business cycle properties of real macroeconomic variables in the U.S. economy. I consider efficient bargaining that the firm and the worker enter into bargaining over the future nominal hourly wage rate and future hours worked under the generalized Nash bargaining framework. The Nash product is assumed to consist of the discounted present value of the expected match surplus. Under efficient bargaining, the model hardly produces unrealistically high volatility of real variables or countercyclical productivity because hours per worker are fixed ahead of time and employment is a slow-moving variable with search frictions. Moreover, efficient bargaining requires firms to rely on job creation heavily to adjust the wedge between the marginal product of labor and the real wage rate in response to shocks. As contract length increases, the volatilities of the unemployment rate and vacancy rate increase significantly, but those of output and total hours worked do not appreciably change. I also investigate the model under different assumptions such as the right-to-manage approach, the Nash product with the current value of match surplus, and instantaneous hiring. Efficient and forward-looking bargaining are important in accounting for the U.S. business cycle properties.