Inefficient unemployment and bargaining friction

Abstract

This paper examines how bargaining frictions generate privately inefficient job separations and amplify unemployment fluctuations. I propose a simple specification of bargaining friction by including bargaining wedges in the standard Nash bargaining model. Such bargaining wedges arise 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. I highlight a distinct amplification mechanism that operates through the separation margin. The existence of inefficient unemployment due to bargaining friction could accentuate the fluctuation of unemployment. Quantitatively, I find that inefficient unemployment accounts for up to 30% of the total unemployment volatility in the calibrated model.