How does inflation “Grease the Wheels” in a frictional labor market?

Abstract:

This paper studies the role of inflation in greasing the wheels of the labor market. To do so, it unifies the theory of frictional labor markets with a theory of nominal wage adjustment. The model features worker heterogeneity, endogenous quits and layoffs, on-the-job search, and on-the-job wage renegotiation. Renegotiation costs, together with the requirement of mutual agreement, lead to a state-dependent process for on-the-job wage renegotiation. We parametrize the model to match important features of the distribution of wage changes within jobs and across jobs measured with administrative microdata. The new framework reproduces the anatomy of labor market dynamics during inflation surges, such as the ones observed in Argentina's 2001 inflation episode.