Demand and supply effects of bargaining power shocks

- We study the demand and supply effects of wage bargaining in a New Keynesian model
- Most work considers only increased labour demand through lower wages
- Credit constrained consumers induce a negative demand effect upon falling wages
- With lower zero interest rate bound that demand effect outweighs the supply effect
- Slowly adjusting expectations about shock persistence reinforce the demand effect

In times of crisis, social partners may consider a temporary decline in wages as a necessity to maintain employment. This paper studies the opposing demand and supply effects following declining bargaining power of workers in a New-Keynesian model with search and matching in the labour market. Lower labour income reduces aggregate demand in the presence of credit-constrained consumers. The main result is that falling bargaining power contracts output notably when monetary policy is constrained by the zero lower bound or when agents' expectations about the persistence of the shock adjust slowly.