Downward wage rigidity and optimal steady-state inflation PDF Download

Author: Gabriel Fagan
Publisher:
ISBN:
Category :
Languages : en
Pages :

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Author:
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ISBN: 9789289949682
Category :
Languages : en
Pages :

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Standard New Keynesian (NK) models feature an optimal inflation target well below two percent, limited welfare losses from business cycle fluctuations and long-term monetary neutrality. We develop a NK framework with labour market frictions, endogenous productivity and downward wage rigidity (DWR) which challenges these results. The model features a non-vertical long-run Phillips curve between inflation and unemployment and a trade-off between price distortions and output hysteresis that change the welfare-maximizing inflation level. For a plausible set of parameters, the optimal inflation target is in excess of two percent, a target value commonly used across central banks. Deviations from the optimal target carry welfare costs multiple times higher than in traditional NK models. The main reason is that endogenous growth and DWR generate asymmetric and hysteresis effects on unemployment and output. Price level targeting or a Taylor-rule responding to the unemployment rate can handle better the asymmetric and hysteresis effects in our model and deliver significant welfare gains. Our results are robust to the inclusion of the effective lower bound on the monetary policy interest rate.

Author: Sachiko Kuroda
Publisher:
ISBN:
Category : Unemployment
Languages : en
Pages : 50

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Author: Niloufar Entekhabi
Publisher:
ISBN:
Category :
Languages : en
Pages : 0

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This paper brings the elements of growth to the standard New Keynesian model to analyze the optimal rate of inflation. To our knowledge, this is the first theoretical attempt to consider the effects of growth in the determination of optimal monetary policies. With both elements of price and wage rigidities, inflation creates distortions due to wage and price dispersions and due to its effects on monopolistic mark-ups by price and wage setters. The choice of the optimal inflation rate balances these distortions at the margin. The paper first characterizes these tradeoffs in the steady-state version of the model and finds that, for a wide range of parameter values, the optimal rate of inflation is negative. When the monetary policy is committed to adjust nominal interest rates to ensure its objective of price stability, it might target a deflation rate. This is due to the fact that the mean of inflation is affected by shocks, and on average, this mean is approaching zero. The welfare analysis then reveals that real growth decreases the welfare cost of inflation.

Author: Stephan Fahr
Publisher:
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Category :
Languages : en
Pages : 0

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This paper analyses the implications of heterogeneity in the type of downward wage rigidity (nominal or real) for optimal monetary policy in a monetary union with asymmetric wage adjustment costs. Indexation in one region of the union reduces optimal grease inflation in the presence of common productivity shocks. Large common shocks may have sizeable and persistent effects on the intra-union terms of trade, whereby the region characterized by downward real wage rigidity adjusts with a persistent loss of competitiveness. In response to asymmetric productivity shocks, there is no role for grease inflation because relative price changes facilitating the real wage changes dominate the adjustment mechanism.

Author: Pierpaolo Benigno
Publisher:
ISBN:
Category : Wages
Languages : en
Pages : 38

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In the presence of downward nominal wage rigidities, wage setters take into account the future consequences of their current wage choices, when facing both idiosyncratic and aggregate shocks. We derive a closed-form solution for a long-run Phillips curve which relates average output gap to average wage inflation: it is virtually vertical at high inflation and flattens at low inflation. Macroeconomic volatility shifts the curve outward and reduces output. The results imply that stabilization policies play an important role, and that optimal inflation may be positive and differ across countries with different macroeconomic volatility.

Author: Dany Brouillette
Publisher:
ISBN:
Category : Inflation targeting
Languages : en
Pages : 13

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"Recent evidence suggests that the extent of downward nominal wage rigidity (DNWR) inthe Canadian labour market has risen following the 2008-09 recession. This note studies whether DNWR can lead to a long‐run trade‐off between inflation and unemployment, especially at lower rates of inflation-a question that has important implications for the optimal level of inflation in the long run. The results suggest that the trade‐off between unemployment and inflation remains weak despite the estimated increase in DNWR. In particular, the long‐run Phillips curve is close to vertical at inflation rates of 2 per cent or more, in line with earlier findings. As a result, an increase in long‐term inflation from 2 to 3 per cent would lower unemployment by about 0.1-0.2 percentage points. Overall, our results suggest that the benefits of raising the inflation target to attain a lower long‐term unemployment level seem rather weak"--Abstract, p. iii.

Author: Mr. Luca Antonio Ricci
Publisher: International Monetary Fund
ISBN: 1451916175
Category : Business & Economics
Languages : en
Pages : 49

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Wage setters take into account the future consequences of their current wage choices in the presence of downward nominal wage rigidities. Several interesting implications arise. First, a closed-form solution for a long-run Phillips curve relates average unemployment to average wage inflation; the curve is virtually vertical for high inflation rates but becomes flatter as inflation declines. Second, macroeconomic volatility shifts the Phillips curve outward, implying that stabilization policies can play an important role in shaping the trade-off. Third, nominal wages tend to be endogenously rigid also upward, at low inflation. Fourth, when inflation decreases, volatility of unemployment increases whereas the volatility of inflation decreases: this implies a long-run trade-off also between the volatility of unemployment and that of wage inflation.

Author: Ben S. Bernanke
Publisher: University of Chicago Press
ISBN: 0226044734
Category : Business & Economics
Languages : en
Pages : 469

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Over the past fifteen years, a significant number of industrialized and middle-income countries have adopted inflation targeting as a framework for monetary policymaking. As the name suggests, in such inflation-targeting regimes, the central bank is responsible for achieving a publicly announced target for the inflation rate. While the objective of controlling inflation enjoys wide support among both academic experts and policymakers, and while the countries that have followed this model have generally experienced good macroeconomic outcomes, many important questions about inflation targeting remain. In Inflation Targeting, a distinguished group of contributors explores the many underexamined dimensions of inflation targeting—its potential, its successes, and its limitations—from both a theoretical and an empirical standpoint, and for both developed and emerging economies. The volume opens with a discussion of the optimal formulation of inflation-targeting policy and continues with a debate about the desirability of such a model for the United States. The concluding chapters discuss the special problems of inflation targeting in emerging markets, including the Czech Republic, Poland, and Hungary.

Author: Emrehan Aktuğ
Publisher:
ISBN:
Category :
Languages : en
Pages : 0

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My dissertation investigates the nonlinear dynamics in business cycles and the transmission of monetary policy using both empirical and theoretical frameworks. Chapter 1 examines the impact of macroeconomic asymmetry on the welfare cost of business cycles. I investigate the welfare cost of business cycles due to asymmetries generated by two occasionally binding constraints (OBCs): downward nominal wage rigidity (DNWR) and zero lower bound (ZLB). Although business cycle volatility has declined recently as the Great Moderation literature suggests, I find that the welfare cost of business cycles has doubled due to the increased skewness of business cycles over time that is apparent in the data. In a quantitative dynamic equilibrium model that accounts for volatility and skewness changes in pre and postVolcker periods, I estimate that the welfare cost of business cycles has increased from 0.57% (in terms of consumption equivalence) in the pre-Volcker period to 0.97% in the post-Volcker period. Counterfactual analysis shows that while both OBCs play a role, the binding ZLB explains most of the welfare effects in the post-Volcker period. Policy counterfactuals indicate that increasing the inflation target from 2% to 4% reduces the skewness of business cycles and the binding rates of both OBCs, thereby leading to a significant decrease in the welfare cost, from 0.97% to 0.67%. In Chapter 2, I investigate the welfare maximizing steady-state inflation rate in a heterogeneousagent New Keynesian model with Downward Nominal Wage Rigidity (DNWR). After matching the annual wage change distribution in the U.S., I show that DNWR has a very significant impact on the economy when the inflation target is low. Considering the effect of the zero lower bound, price dispersion due to sticky prices, declining natural rate of interest, and lower trend productivity, I find that the optimal inflation target should be much higher than 2%, close to 7%. This result holds taking transition dynamics into account and is robust to a wide range of parameterizations. Lastly, Chapter 3 analyzes the impact of heterogeneity in wage and price stickiness on the transmission of monetary policy. Using the price and wage rigidity estimates of previous studies, I find a slightly negative correlation between wage and price rigidity at the industry level. After categorizing 3-digit industries as rigid and flexible, I analyze the impulse responses of real variables to a monetary policy shock. I document a significant response of industrial production in price-rigid industries, whereas in wage-rigid industries the response is still significant but weaker. Consistent with the theory, the response in price- and wage-flexible industries is not significant. The empirical results suggest that due to relatively lower variation in wage stickiness at the industry level, price stickiness plays a more important role in the differential response of industries to a monetary policy shock. Besides, I develop a multi-sector model incorporating sector-level heterogeneity both in wage and price rigidity into an otherwise standard New Keynesian model and analyze the monetary non-neutrality for different specifications. The results of the model verify the empirical findings