The Conquest of U.S. Inflation in an Estimated DSGE Model with Labor Market Search

This paper estimates a monetary DSGE model with labor market search with Bayesian methods to explain the fall in U.S. inflation in the 1980s and 1990s. After the high inflation of the 1970s, the U.S. have experienced low and stable for two decades. An obvious reason for the fall in inflation is the improved monetary policy: policy mistakes are often indicated as responsible for the run-up of inflation in the 1970s; better policy instead has managed to keep inflation under control later on. The paper aims to investigate if other changes in the structure of the economy, which are typically ignored in the literature, might have simplified the task of monetary policy. In particular, I investigate whether changes in the labor markets over time might have contributed in keeping inflation under control. To this scope, I introduce labor search in a monetary DSGE model with sticky prices. In the estimation, I allow for time-variation in the estimated relative bargaining power between firms and workers. The focus is in studying if a reduced workers’ bargaining power in the 1980s-1990s, by stabilizing wages, might have importantly worked to contain inflation.