The Calmfors-Driffill Hypothesis with Labour Market Frictions and Regulated Goods Markets

• Authors: Valeri Sorolla.
• BSE Working Paper: 110362 | March 16
• Keywords: monopolistic competition , Disequilibrium Unemployment , wage setting systems , policy reforms
• JEL codes: E24, O41
• monopolistic competition
• Disequilibrium Unemployment
• wage setting systems
• policy reforms

In this paper we present an unemployment model with labour market frictions and monopolistic competition in the goods market. We consider different collective wage-setting systems and compare wages, the unemployment rate and labour market tightness at firm, sector and national (centralized) levels. We find that the Calmfors-Driffill hypothesis is maintained under labour market frictions. In other words, unemployment will be thighest when the bargaining occurs at an industry-wide level. We find, both empirically and analytically, that regulation in the goods market plays a crucial role in explaining these findings. It may contribute to explaining the historical relationship between wage bargaining institutions and unemployment. Additionally, we show that the Calmfors-Drifill results are conditioned by the tax structure and the progressivity of labour income taxes. This fact might explain the lack of robustness in the findings relating to the relationship between wage bargaining institutions and unemployment of many empirical studies on the Calmfors-Driffill hypothesis.