Working Paper No. 375 Inflation dynamics with labour market matching: assessing alternative specifications

This paper reviews recent approaches to modelling the labour market, and assesses their implications for inflation dynamics through both their effect on marginal cost and on price-setting behaviour. In a search and matching environment, we consider the following modelling set-ups: right-to-manage bargaining versus efficient bargaining, wage stickiness in new and existing matches, interactions at the firm level between price and wage-setting, alternative forms of hiring frictions, search on-the-job and endogenous job separation. We find that most specifications imply too little real rigidity relative to the data and, so, too volatile inflation. Models with wage stickiness and right-to-manage bargaining, or with firm-specific labour emerge as the most promising candidates.