Inflation and Real Wage Dispersion: A Model of Frictional Markets

Abstract

Current Population Survey (CPS) data over the period from 1994 to 2008 show that inflation has a positive effect on the residual wage dispersion. To explain this phenomenon, we introduce uncoordinated job searches into a general equilibrium monetary search framework. Our model shows that the uncoordinated job searches by unemployed workers give rise to an equilibrium, where a firm is matched with zero, one, or multiple job applicants. The ex post difference in matching probabilities generates a two-point wage dispersion among identical workers, when the Mortensen rule is implemented in the wage-determination process. In our model, inflation positively influences the wage dispersion directly through its impact on firm's real profit and indirectly through the effect of inflation that spills over from the goods market to the labor market. With reasonable parameter values, the calibrated model can account for most of the observed responses of residual wage dispersion to inflation.

Directed Search and Competitive Search Equilibrium: A Guided Tour

“…There is no CM in this environment, but it can be interesting to add one(Berentsen, Menzio, and Wright 2011;Gomis-Porqueras, Julien, and Wang 2013;Zhang and Huangfu 2018; Dong and Xiao 2014).…”