A BEJM Advances article.

Abstract

We develop a New Keynesian model with staggered price and wage setting where downward nominal wage rigidity (DNWR) arises endogenously through the wage bargaining institutions. It is shown that the optimal (discretionary) monetary policy response to changing economic conditions then becomes asymmetric. Interestingly, in our baseline model we find that the welfare loss is actually slightly smaller in an economy with DNWR. This is due to that DNWR is not an additional constraint on the monetary policy problem. Instead, it is a constraint that changes the choice set and opens up for potential welfare gains due to lower wage variability. Another finding is that the Taylor rule provides a fairly good approximation of optimal policy under DNWR. In contrast, this result does not hold in the unconstrained case. In fact, under the Taylor rule, agents would clearly prefer an economy with DNWR before an unconstrained economy ex ante.

Submitted: August 7, 2008 · Accepted: October 16, 2008 · Published: October 30, 2008

Recommended Citation

Carlsson, Mikael and Westermark, Andreas (2008) "Monetary Policy under Downward Nominal Wage Rigidity," The B.E. Journal of Macroeconomics: Vol. 8 : Iss. 1 (Advances), Article 28.
DOI: 10.2202/1935-1690.1809
Available at: http://www.bepress.com/bejm/vol8/iss1/art28