Monetary Policy and Productivity Shocks with Endogenous Hours and On-the-Job Search

Abstract

This paper develops a New Keynesian model with on-the-job search. Workers are allowed to search on the job in order t o find a better job. I analyze how output, consumption, inflation, unemployment, and t he other labor market variables respond to productivity and monetary policy shocks. I allow the labor input to change both at the extensive margin and at the inte nsive margin. This generates a lower elasticity of marginal cost with respect to o utput which is important in obtaining the sluggish response of inflation. I fin d that output and consumption show large and persistent responses to productivity and monetary policy shocks, whereas labor market variables do not show persiste nt effects and adjust very quickly in response to monetary policy shocks. On-t he-job search mechanism also eliminates the need for exogenous wage rigidity and reduces the average duration of price contracts, which is consistent with the micro data. The increasing search activity by the employed creates an incentive for t he firms to post vacancies and helps in achieving the relatively smooth behavior o f wages over the cycle without assuming any exogenous and ad-hoc wage rigidity.