A new Keynesian model with overtime labor

Abstract

This paper extends the standard New Keynesian model by incorporating labor adjustment costs and overtime work. I show that labor frictions help reconcile the frequent price changes found in the microdata with the degree of sluggishness in inflation adjustment to output changes at the macro level.

The introduction of labor frictions affects the dynamic behavior of economic variables (particularly employment and inflation) and implies that firms marginal costs should be measured in overtime costs. Marginal costs measured in overtime hours are procyclical and are predicted by inflation as suggested by theory