Unemployment as excess supply of labor: Implications for wage and price inflation

The introduction of both market-clearing wages and nominal rigidities on wage setting can be used to rationalize unemployment as excess supply of labor in the New Keynesian model. As a result, wage inflation dynamics are forward-looking and depend negatively on the rate of unemployment. Moreover, both price inflation and wage inflation evolve as indicated by equations equivalent to those obtained in , though with different slope coefficients. In an equal-volatility comparison, the model with unemployment conveys less price stickiness and more wage stickiness.