Study refines Phillips Curve with monopsonistic wage-setting

A new DSGE model introduces firms' monopsonistic wage-setting, a departure from standard models that assume households' monopolistic wage-setting.

This innovation allows for the identification of shocks to the wage markdown as labor demand shocks, a feature previously absent.

The model empirically outperforms its standard counterpart, demonstrating that both labor demand and supply shocks are indispensable for its superior performance in accounting for US business cycles and inflation dynamics.

This separate identification of labor demand and supply shocks is crucial.

Furthermore, the estimated model restores a robust relationship between inflation and real marginal cost, a connection often elusive in empirical research using real unit labor cost as a proxy.

This refinement enhances the Phillips curve's descriptive power for inflation dynamics.

The model refines real marginal cost by allowing real unit labor cost to be decomposed into real marginal cost and the wage markdown.

This refined measure shows a strong correlation with inflation data, unlike traditional real unit labor cost proxies.

This enables the model to attribute inflation fluctuations to a broad mix of shocks affecting real marginal cost, such as monetary policy and productivity shocks, rather than relying on price markup shocks.

This contrasts with standard models, which often attribute inflation largely to price and wage markup shocks.

The findings also extend understanding of the labor wedge, showing its decomposition into real marginal cost and the wage markdown, which improves the model's empirical performance.