Efficiency Wage and Cyclical Asymmetry

This paper examines the cyclical implications of the efficiency wage model for the labor market and inflation dynamics in a New Keynesian framework with search frictions. Shapiro and Stiglitz's (1984) efficiency wage framework is incorporated into the otherwise ordinary Nash-bargaining wage determination, thereby generating downward real wage rigidity over business cycles. Introducing the efficiency wage scheme enables the model to replicate the asymmetric dynamics of real activity indicators, especially labor market quantities, observed in the data; the model exhibits a significantly left-skewed distribution for employment, vacancy, and real output. Furthermore, real wage rigidity induced by the efficiency wage scheme can address Shimer's (2005) volatility puzzle and explain the observed weak cyclicality of real wages.