Staggered contracts and persistence: microeconomic foundations and macroeconomic dynamics

Abstract

We develop in this article a new form of wage contracts similar in spirit to those developed by Calvo (1983), and integrate these contracts into a dynamic stochastic general equilibrium model. Rational wage setting by utility maximizing trade-unions is explicitly modelled. We derive the optimal wage contracts, and compute the dynamic macroeconomic response to monetary shocks. It is shown that, unlike in most traditional models, this response can display strong persistence, a hump shaped response and positive autocorrelations in output and employment variations. All these results are obtained in a model with explicit closed-form solutions.