A Non-Walrasian Labor Market and the European Business Cycle

This paper investigates to what extent a New Keynesian, monetary model with the addition of a microfounded, non-Walrasian labor market based on union bargaining is able to replicate key aspects of the business cycle. The presence of a representative union offers an explanation for two features of the cycle. First, it generates an endogenous mechanism which produces persistent responses of the economy to both supply and demand shocks. Second, labor unionization causes a lower elasticity of marginal costs to output. This leads to lower inflation volatility. The model can replicate the negative correlation between productivity shocks and employment in the data. Model simulations show the superiority of the unionized framework in reproducing European business cycle statistics relative to a model with a competitive labor market. JEL: E24, E31, E32.