Fixing the Phillips Curve: Implications of Firms' Monopsonistic Wage-setting for Inflation Dynamics

Motivated by evidence documented in labor economics, we introduce firms' monopsonistic wage-setting in an otherwise standard DSGE model. Our model identifies shocks to the wage markdown as labor demand shocks—a feature absent from standard models. With both labor demand and supply shocks, our model empirically outperforms its standard counterpart model. Firms' monopsonistic wage-setting allows real unit labor cost to be decomposed into not only real marginal cost but also the wage markdown. This refined measure of real marginal cost enhances the Phillips curve's ability to describe inflation dynamics while obviating the need for price markup shocks.