Working Paper

When Hosios Meets Phillips: Connecting Efficiency and Stability to Demand Shocks

Abstract: 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.

Keywords: aggregate demand; unemployment; search and matching frictions; market power; constrained efficiency; wage-inflation Phillips curve;

JEL Classification: E24; E32; J63; J64;

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Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2021-02-17

Number: 2018-13

Note: The first version of this paper was published September 27, 2018, as "Efficiency in Sequential Labor and Goods Markets".

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