Bargaining power and the Phillips curve: a micro-macro analysis

Summary

Focus

The relationship between inflation and economic activity has apparently weakened in recent years. We ask how trends in workers' bargaining power may have played a role.

Contribution

We use a general equilibrium model to show that, when workers' bargaining power weakens, firms to react to lower demand by cutting the number of workers (extensive margin) rather than reducing the hours per employee (intensive margin). Since the marginal cost increases with hours per employee, this affects production costs and hence inflation.

Findings

Using aggregate data for the euro area, we confirm that the decline in workers' bargaining power has weakened the relationship between inflation and economic activity. Our findings gain support from a survey of Italian industrial firms, which shows that the more unionised firms tend to cut working hours per employee (ie adjust the intensive margin of labour) to a greater extent when demand falls.

Abstract

We use a general equilibrium model to show that a decrease in workers' bargaining power amplifies the relative contribution to the output gap of adjustments along the extensive margin of labour utilization. This mechanism reduces the cyclical movements of marginal cost (and inflation) relative to those of the output gap. We show that the relationship between bargaining power and adjustments along the extensive margin (relative to the intensive margin) is supported by microdata. Our analysis relies on panel data from the Italian survey of industrial firms. The Bayesian estimation of the model using euro-area aggregate data covering the 1970-1990 and 1991-2016 samples confirms that the decline in workers' bargaining power has weakened the inflation-output gap relationship.

JEL classification: E31, E32, J23, J60

Keywords: low inflation, bargaining power, Phillips curve