The dynamics of wages and employment in a model of monopolistic competition and efficient bargaining

Modern macroeconomic models with a Keynesian flavour usually involve nominal rigidities in wages and commodity prices. A typical microfoundation recurs to wage bargaining in the labour markets and monopolistic competition in the commodity markets (e.g. Blanchard/Giavazzi). A characteristic feature of those models is that deregulating the labour markets (i.e. reducing the bargaining power of workers and/or reducing the unemployment benefits) increases equilibrium employment; in a symmetric way, deregulating the commodity markets (i.e. reducing the market power of commodity suppliers) increases equilibrium employment as well. However, those models are typically static models which do not specify explicitly the economic process in time. In the following paper, we develop a dynamic macroeconomic model in which commodity markets are characterised by monopolistic competition and labour markets by wage bargaining. In this first version, the number of firms is fixed. The incorporation of firm entry and exit is left for further research. In our analysis the usual equilibrium solution is a fixed point of the dynamic model which exhibits the usual comparative static properties (deregulating the labour and/or the commodity market increases employment). However, depending upon the parameters the fixed point may loose stability through a Flip-bifurcation giving rise to cyclical solutions. We show that commodity and labour market deregulation may lead to instability and lower average employment. This result, valid in a dynamic framework, contrasts with the usual comparative static properties.