The role of contracting schemes for the welfare costs of nominal rigidities

Matthias Paustian

No 196, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: This paper asks the following two questions: First, can a model with nominal rigidities in wage and price setting account for the average welfare costs of business cycle fluctuations identified in Gali, Gertler, and Lopez- Salido (2003)? Second, what is the role of contracting schemes for the welfare costs of business cycle fluctuations? We compute a quadratic approximation to agents expected lifetime utility and evaluate welfare for different modeling schemes of nominal rigidities that all have the same average duration of contracts. Calvo (1983) wage and price contracts can deliver sizeable welfare costs, but other contracts of the same average stickiness cannot. Calvo (1983) contracts can imply welfare costs that are up to 4 times higher than those implied by overlapping contracts in the spirit of Taylor (1980) or Wolman (1999). Furthermore, the sticky information framework of Mankiw and Reis (2002) may generate welfare costs that are even smaller. This paper calls for more research into the origins of wage and price stickiness

Keywords: welfare; Calvo; Taylor; sticky information; costs of nominal rigidities (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Date: 2005-11-11
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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