Asset prices, growth and endogenous wage inertia

We study asset prices in a search and matching model of endogenous wage inertia and growth based on innovation. The previous literature emphasizes that recessions characterised by lower consumption and innovation spending lead to an endogenous slowdown in productivity leaving permanent scars on the economy (keeping actual output permanently below its previous trend). In this paper, we show that accounting for fluctuations in unemployment and new hires makes these scars deeper and also magnifies the fall in asset prices and the rise in risk premia. We have a number of additional findings. First, we show that previous models with wage-setting frictions mainly raise the amount of business cycle risks (with a frequency of 2-8 years) even in a growth setting. Second, we find that search and matching models with either Nash or alternating offer wage bargaining amplify risks both at the business-cycle and growth cycle (25-50 years) frequencies. Third, dividends are less countercyclical (the firm is less safe) in models of endogenous wage inertia. Finally, these search and matching models generate higher risk-premia and match US data 1929-2017 better compared to models with wage-setting frictions.