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 frame-work with search frictions. Shapiro and Stiglitz’s (1984) efficiency wage frame-work is incorporated into the otherwise ordinary Nash-bargaining wage deter-mination, thereby generating downward real wage rigidity over business cycles. Introducing the efficiency wage scheme enables the model to replicate the asym-metric 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 in-duced by the efficiency wage scheme can address Shimer’s (2005) volatility puz-zle and explain the observed weak cyclicality of real wages.