Inefficient Unemployment and Bargaining Friction

Abstract

This paper explores the possibility of privately inefficient job separations due to bargaining friction and its implications for the unemployment dynamics. I propose a simple specification of bargaining friction by including bargaining wedges in the standard Nash bargaining model. Such bargaining wedge arises when, for example, wages are determined by alternating offers bargaining, which is often used in the literature to generate real wage rigidity, or when there is asymmetric information about worker's productivity. I show that due to the misalignment between actual surpluses and bargaining surpluses, inefficient separations could be generated which would in turn induce inefficient unemployment. The existence of inefficient unemployment due to bargaining friction could potentially explain the excessive fluctuation of unemployment observed in the data. Quantitatively, I find that inefficient unemployment constitutes up to 44% of the total unemployment volatility in the calibrated model.

Keywords: inefficient unemployment, bargaining friction, inefficient separation, unemployment volatility, alternating offers bargaining, asymmetric information

JEL Classification: C78, E24, E32, J63, J64