The Search Costs of Inflation in the Labor Market

Abstract

This paper studies the effect of unanticipated inflation in the labor market. When wages are contracted in nominal terms, inflation reduces real wages, leading workers to intensify on-the-job search to obtain wage-adjusting outside offers. Both the search effort and the resulting job mobility are costly, yet that same mobility raises output by moving workers toward more productive matches. To quantify these costs and benefits, we extend the canonical job ladder of Postel-Vinay and Robin (2002) to a nominal environment with privately chosen search effort, and calibrate it to standard moments from the pre-pandemic US labor market. A one-time inflation shock scaled to the COVID episode generates an average welfare loss of 0.44% of consumption, with workers at the top of the wage distribution bearing losses over six times those at the bottom. Once the offsetting transfer of surplus to firms and productivity gains from reallocation are accounted for, the net aggregate cost is close to zero. Second, inflation volatility imposes asymmetric costs: worker welfare is approximately invariant to the volatility regime because firms compensate workers for expected search costs at hiring, but social welfare declines meaningfully because the resource cost of search effort is not undone by compensation. This second finding identifies a distinct, labor-market source of welfare costs from inflation volatility, complementing the price-dispersion costs emphasized in the New Keynesian literature.