A business-cycle model with monopolistically competitive firms and Calvo wages: lessons for Bulgaria

Abstract

Purpose: The author augments an otherwise standard business-cycle model with a rich government sector and adds monopolistic competition in the product market and rigid prices, as well as rigid wages a la Calvo (1983) in the labor market. Design/methodology/approach: This specification with the nominal wage rigidity, when calibrated to Bulgarian data after the introduction of the currency board (1999–2018), allows the framework to reproduce better observed variability and correlations among model variables and those characterizing the labor market in particular. Findings: As nominal wage frictions are incorporated, the variables become more persistent, especially output, capital stock, investment and consumption, which help the model match data better, as compared to a setup without rigidities. Practical implications: The findings suggest that technology shocks seem to be the dominant source of economic fluctuations, but nominal wage rigidities as well as the monopolistic competition in the product market, might be important factors of relevance to the labor market dynamics in Bulgaria, and such imperfections should be incorporated in any model that studies cyclical movements in employment and wages. Originality/value: The computational experiments performed in this paper suggest that wage rigidities are a quantitatively important model ingredient, which should be taken into consideration when analyzing the effects of different policies in Bulgaria, which is a novel result.