Wage contracts and business cycle models

Abstract

The paper introduces an explicit production technology into a business cycle model with nominal rigidities and evaluates the modified model using criteria similar to those commonly used to assess real business cycle (RBC) models. In general, the model compares favorably to standard RBC models, and is superior in several important respects. It reproduces the observed correlation of average labor productivity and hours as well as the relative volatilities of hours and output, and requires technological shocks of a lower magnitude to generate the observed volatility of output. Finally, the modified model is capable of reproducing some of the stylized response patterns from the recent empirical literature.