Dynamic Wage Bargaining and Labour Market Fluctuations: The Role of Productivity Shocks

In this paper, we explore the way in which different bargaining settings affect labour market fluctuations by means of an analytical apparatus that has never been used for this purpose. Specifically, modelling wage negotiations as a problem of stochastic optimal control, we analyse how productivity disturbances shape the dynamics of output, employment, and wages by focusing on the way in which firms' technology and workers' preferences interact with the adjustment rules of employment underlying the bargaining process. With a quadratic production function and risk averse workers, we show that wage negotiation outcomes whose employment adjustments go in the direction of the labour demand of the firms match the cyclical behaviour of the involved variables but fail to replicate the observed wage rigidity. By contrast, we show that wage bargaining outcomes whose employment adjustments target the contract curve of two negotiating parties are also able to deliver a strong degree of wage stickiness.