Price Bargaining and the Business Cycle

This paper models a segmented production sector with price bargaining between the intermediate good firm and the final good firm. We show how to incorporate price bargaining in an otherwise standard New Keynesian model and discuss its macroeconomic implications. Estimating the model on U.S. data using Bayesian methods, we find that the intermediate good firm has 50 percent of the bargaining power. We find that the size of the bargaining power determines the quantitative and qualitative macroeconomic effects. -- Further, we quantify the size of switching costs: they are equal to about two percent of output. Shocks to switching costs are specific to this model and generate sizable macroeconomic fluctuations.